{"id": "000b98d4-201b-4ce8-9c8e-1006ac5576f6", "companyName": "Ligand Pharmaceuticals Incorporated", "companyTicker": "LGND", "quarter": 3, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2021/11/10/ligand-pharmaceuticals-incorporated-lgnd-q3-2021-e/", "content": "Ligand Pharmaceuticals Incorporated\u00a0(LGND -1.38%)\nQ3\u00a02021 Earnings Call\nNov 9, 2021, 4:30 p.m. ET\n\nOperator\n\nGood day and thank you for standing by. Welcome to the Ligand Pharmaceuticals Third Quarter Earnings Call. [Operator Instructions.]\n\nI'd now like to hand the conference over to your first speaker for today, Mr. Simon Latimer, Head of Investor Relations. Please go ahead sir.\n\nSimon Latimer -- Investor Relations\n\nThanks Eli. Welcome to Ligand's third quarter of 2021 financial results and business update conference call. Our speakers for today's call are in separate locations. Speaking today for Ligand will be John Higgins, CEO; Matt Foehr, COO; and Matt Korenberg, CFO. We will use non-GAAP financial measures and some of our statements will be forward-looking, including those related to our financial condition, results of operations, financial guidance, the impact of the COVID-19 pandemic and plans for OmniAb to become a stand-alone public company.\n\nAdditional information concerning risk factors and other matters concerning Ligand can be found in our earning press release and our periodic filings with the SEC. We undertake no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call. A reconciliation between the non-GAAP financial measures we discuss and the closest GAAP financial measure can be found in our earnings release issued today.\n\nI would now like to turn the call over to John Higgins.\n\nJohn Higgins -- Chief Executive Officer\n\nSimon, thank you. Good afternoon, and thanks for joining our third quarter 2021 earnings call. Today we have an outstanding quarterly report for our shareholders, we have the highest ever royalties for our largest partner products, we've had a string of partner successes with several approvals in recent months, and launches are now underway that we expect will fuel growth and royalty revenue for years to come. In addition, there's been tremendous progress by our partner, especially around our OmniAb platform. Today on our call, we also provide more information about our work to split Ligand into two separate companies. First, some remarks about our Q3 financial and operating performance.\n\nRoyalties are the main revenue driver for our company and after a solid second quarter for our lead products, we are very pleased to see our partners post higher revenue than we expected for KYPROLIS and for EVOMELA here in the third quarter. This is the highest quarter ever for royalties on both products and we see the momentum continuing into the fourth quarter and next year. For KYPROLIS both Amgen and Ono posted great Q3 results. And we are looking forward to the launch of the product in China by Beijing, which we believe will drive further growth. EVOMELA continues to perform well with both our US and Chinese marketing partners with a 20% royalty. This product is beginning to be a major contributor to our bottom line.\n\nJust since June, we've seen Jazz receive approval for Rylaze in the US, KYPROLIS get approval in China, Merck announced US approval for VAXNEUVANCE and Gloria report approval of zimberelimab in China, which is the first approval for an OmniAb derived antibody. This all follows the Serum Institute of India's launch of Numa cell, which also occurred earlier this year. We'll collect royalties on all these products. It's a great string of news over the last several quarters. Now, Matt four will go into more detail on several of our lead partner program, but I will highlight sparsentan, our partner program with Travere Therapeutics. This is a major asset for Ligand Gant that has made tremendous progress this year. In August Travere announced positive top line, interim results from the ongoing Phase III study of sparsentan in IGA nephropathy.\n\nSparsentan treatment demonstrated a statistically significant reduction of Scenario from baseline after 36 weeks that was more than threefold the reduction from the active comparator silicon [Phonetic]. Travere plans to submit for accelerated approval in the US for this indication in the first quarter of next year. Travere also reported that they met with the FDA for Sparsentan in FSGS, and they confirmed plans to submit additional data in the first half of 2022, as part of an accelerated approval process for that indication. This is a program that has the potential to emerge as our largest royalty driver over the next few years, given the substantial market need and our loyalty rate. As for our plans to split the company, given our success, growth and evolution of our business, it has become increasingly clear that Ligand would be better positioned to drive value for partners and our shareholders by operating as two separate independent companies.\n\nOur core business model at Ligand is built around technology licensing, coupled with revenue sharing with our partners through royalties. We are now at an inflection point where we anticipate significant top line growth by existing and new royalties that should fuel superior bottom line results and cash flow as we manage a lean operating structure, We have talked with investors for years about our vision for growth driven by a diverse portfolio of royalties to drive cash flow. We've had a string of smart acquisitions, including our well timed transaction with Phoenix last year. And we have patiently awaited partner data readouts and approvals. The planning and patience have paid off as we believe the royalty business is now positioned to thrive.\n\nAt the same time, our progress and success with our OmniAb platform has far exceeded our expectations. We entered the antibody research tool space six years ago with our acquisition of OMT, an industry-leading antibody discovery platform. At that time, our antibody business had only 15 partners with discovery stage programs. No clinical trials had been initiated, there was no human data and we had just two members of the team driving the research and licensing. Today, we have more than 50 partners with access to the OmniAb antibodies and over 200 programs, substantial positive clinical success, our first partner approval and another antibody in line for a potential approval by end of this year. Simply put the OmniAb business is bigger, better and further along than we expected just a few years ago.\n\nOur success is a result of the decisions we've made for how we built out and invested into the platform. The acquisitions we made to bolster the platform and strong licensing and our excellent partner management. Antibody-based medicines are among the best selling products in the pharmaceutical industry these days. And antibody R&D is one of the biggest areas of investment by drug companies. And we now proudly have a leading tech platform that we continue to strengthen even further. We are at the right place at the right time with the right platform. With our success in considering input from partners over the past year or so, it has become clear we should structure the business for future growth and success with a dedicated operating team and board with deep domain expertise to drive strategy and investment.\n\nThe potential and opportunity are simply too substantial to continue under the Ligand parent company. We are pursuing the path to split Ligand from a position of strength and good timing. The remaining company based on royalties and financial performance has never been better positioned to thrive given our product roster, revenue diversity and portfolio, and OmniAb is now a substantial, established technology leader in the antibody R&D space with a strong and well-earned reputation within the industry. In addition, the equity capital markets are validating quality platforms with dedicated investors and analysts who follow the industry.\n\nWe have the assets and the teams to run two great companies, one OmniAb and one Ligand; the two companies who have dedicated operational focus, business specific capital allocation, agility to meet partner needs and compelling focused investment profiles. We are excited about our planning and the potential to provide two companies for our shareholders to own and gain value.\n\nI will now turn the call over to Matt Korenberg for a review of our financials and more discussion about the plans underway to split the companies.\n\nMatthew Korenberg -- Executive Vice President of Finance and Chief Financial Officer\n\nThanks, John. The third quarter of 2021 was a very good quarter for Ligand, both operationally and financially. In addition to the strong financial results that I'll cover today during the quarter we saw approvals for Rylaze, VAXNEUVANCE and zimberelimab, all drugs that we believe will help fuel the growth and royalty revenue for years to come. Turning to the financials, total revenues for the quarter were $64.8 million up 55% from $41.8 million a year ago. Royalty revenue increased 74% to $15.6 million from $9 million a year ago. Royalty revenues comprised principally of KYPROLIS and EVOMELA royalties.\n\nOur growth in royalty revenue reflect strong sales growth for both these products in addition to contributions from several programs backed by our Pelican expression technology, including Rylaze from Jazz, PNEUMOSIL from the Serum Institute of India and Teriparatide from Alvogen. Captisol sales we're $35.1 million in the quarter and this is up 50% from $23.4 million a year ago. Our Q3 Captisol revenue exceeded our internal expectations. Contract revenue in Q3 2021 was $14.1 million compared with $9.5 million a year ago. The 2021 quarter included significant contributions from Pelican with $7 million of approval and launch milestones received for Rylaze and VAXNEUVANCE combined.\n\nOur GAAP EPS for the quarter was $0.80 and our adjusted diluted EPS for Q3 2021 was a $1.58 compared with $1.04 last year or an increase of 52%. We exited the quarter with approximately $323 million cash, cash equivalence and short term investments. Turning to financial guidance, we're reaffirming our guidance for 2021 revenue and adjusted diluted EPS. We expect full year 2021 total revenues to be between $265 million and $275 million and adjusted earnings per diluted share to be between $5.80 and $6.05. With respect to Q4, our year to date results combined with our full year guidance imply about $60 million to $70 million of Q4 revenue. Within that, we expect royalties to grow more than 30% over the year ago period.\n\nWe expect contract revenue of $7 million to $10 million, and we expect the balance of revenue to be from sales of Captisol. Regarding our corporate strategy, as John mentioned, we announced today that we've been conducting a strategic review focused on ways to maximize the value of our OmniAb platform. And we're pursuing a path to create an independent publicly traded company. We acquired the initial OmniAb business in January of 2016. Over the next six years, we significantly grew the business organically and augmented its capabilities with our technology, both on acquisitions of Crystal Bioscience, I Icagen Exela and Taurus.\n\nBased on our strategic review so far, we believe the OmniAb business will be best served as an independent publicly traded company. Preparations are underway to file a confidential S1 with the goal of beginning the process of bringing OmniAb public, following a traditional IPO and then as soon as practical in the future spinning off the entire business to Ligand shareholders. We're extremely excited about this opportunity for OmniAb to invest more significantly in its technology platform and the opportunity to unlock for value for Ligand shareholders.\n\nOur Board of Directors has now approved a specific course of action and will continue to evaluate other options to optimize value and ensure flexibility to invest in growth. And there can be no assurance that this process will result in pursuing a particular transaction or consummating any such transaction. And lastly, I'll just direct listeners to review our Q3 earnings press release issued earlier today and available on our website for reconciliation of adjusted financial results with our GAAP financial results.\n\nAnd with that, I'll turn the call over to Matt Foehr for some comments on our technologies and partner programs. Matt?\n\nMatthew Foehr -- President and Chief Operating Officer\n\nThanks, Matt. As John mentioned, Q3 was a very productive quarter with a number of significant developments for late stage partnered programs. Given the large number of events that occurred, I'm going to review the more recent ones in two categories today, first recent approvals or launches for royalty bearing assets and then significant data readouts or regulatory progress updates. So I'll start now with approvals and launches. Beijing announced the approval of KYPROLIS in combination with dexamethasone in China for the treatment of relapse and refractory multiple myeloma. When Amgen announced its relationship with Beijing, a couple of years back, they highlighted that the alliance would significantly accelerate plans to expand Amgen's oncology presence in China, which is the world's second largest pharmaceutical market.\n\nBeijing is a global research-based oncology focused company with headquarters in Beijing with an established and highly experienced team in China that includes a 700 person commercial organization. So we were very pleased to see news of the approval of KYPROLIS in that market. Our partners at Merck announced FDA approval of VAXNEUVANCE, which is a pneumococcal 15 Valent conjugate vaccine for the prevention of invasive pneumococcal disease in adults 18 years and older. This approval was followed by CDCs ACIP unanimously voting to provisionally recommend VAXNEUVANCE in a series with Pneumovax 23 as an option for pneumococcal vaccination in appropriate adults.\n\nAnd very recently, Merck also disclosed further regulatory progress with VAXNEUVANCE in the pediatric setting, indicating that they have now submitted a supplemental BLA application to the FDA for use in children. It's important to recognize that pneumococcal disease continues to cause serious illness and death worldwide in children under the age of five, despite the positive impact of pneumococcal conjugate vaccine, case numbers and vaccination rates. Certain pneumococcal serotypes put children at particular risk, including serotypes 22F and 33F, which are reported to represent 16% of all cases of invasive pneumococcal disease in children under the age of five.\n\nVAXNEUVANCE is a documented strong immune response to these serotypes and with the inclusion of serotypes 22F and 33F VAXNEUVANCE has the potential to play an important role in the prevention of invasive pneumococcal disease in children worldwide. Our partners at Jazz Pharmaceuticals launched Rylaze in July as a component of a multiagent chemotherapy regimen for the treatment of acute lymphoblastic leukemia, or lymphoblastic lymphoma in adult and pediatric patients who are one month or older, and who have developed hypersensitivity to Ecoli derived asparagine. Jazz provided an update earlier today on their commercial and launch progress with Rylaze noting $21 million in net sales in its first quarter with reports of positive feedback for the drug with ease of ordering dose preparation and for Jazz's support services.\n\nAs a reminder, KYPROLIS uses our Captisol technology in its formulation and both VAXNEUVANCE and Rylaze use elements of Ligand's Pelican expression technology. Also in regulatory approvals, we were pleased to see the first approval of an OmniAb derived antibody when China's NMPA granted marketing authorization to Gloria Biosciences zimberelimab as a second line treatment for relapsed and refractory classical Hodgkin's lymphoma. The first approval is a major event for any innovative technology. So it was gratifying to see this first approval for OmniAb derived zimberelimab. We expect another approval decision later this year for a second OmniAb derived antibody. This one also in China for CStone's sugemalimab as a first line treatment in combo with chemotherapy for stage four squamous and non-squamous cell lung cancer.\n\nBeyond these two medicines, we expect a bright future for OmniAb with potentially many more approvals to follow. Turning now to late stage recent readouts or regulatory or clinical updates from our partners, John already highlighted the late stage in regulatory progress of our partners at Travere Therapeutics, their recent positive data and now with approval submission plans for two indications, both in the US and in Europe. Additionally, our partners at Sermonix announced completion of enrollment in their Phase II ELAINE I randomized trial, assessing oral laser ofloxacin versus intramuscular Fulvestrant for the treatment of ER positive HER II negative breast cancer in patients with an ESR one mutation.\n\nCermonics [Phonetic] expects to report data from the trial in the first half of next year. Oral a is also being studied in a separate, fully enrolled trial named ELAINE II in combination with Lilly's CDK four and six inhibitor Verzenio. Top line data from ELAINE II are also expected in the first half of next year. And I'll conclude this afternoon with a few comments about some of our technologies overall. At Ligand we've assembled and successfully invested in technology that find drugs and make drugs possible. For Pelican, our partners value the fact that the Pelican expression technology is validated by four approved products and is supported by a robust and growing patent portfolio in the area of biosimilars, microbial toxins, and vaccine antigen production, as well as a growing number of patents that cover the technology itself.\n\nThese include promoters, secretion leader sequences, methods for high throughput screening, protein expression, strain engineering and marker systems among others. Together, there are more than 200 issued patents worldwide relating to the Pelican technology and nearly 50 applications now pending. Given the increasing complexities of large molecules in the pharma industry's pipeline, we believe there's never been a better time to own a validated expression technology like Pelican. And I'll conclude my remarks with an overview of OmniAb and the technologies applicable to it anticipated to be included in the separation described in our releases today. Regarding our ion channel tech, our Icogen team in North Carolina has extensive capabilities focused on ion channels and transporters and recently reached a data milestone in its application of high throughput electrophysiology with more than one billion rows of raw data generated over the last couple of years.\n\nThis is a truly impressive accomplishment. The teams downstream processing analysis used bespoke tools developed internally and we're not aware of anyone else who has generated a database like this and as large as this, for this type of ion channel data. In addition, we've advanced our partnership with GSK and entered into a third partner program with Roche earlier in the year. The team also continues to advance a medically important collaboration with the Cystic Fibrosis Foundation. We see very nice potential for future deal flow with this differentiated set of ion channel technologies and with an added focus on our science and capabilities in this area, have opportunities to further leverage and expand the capabilities broadly across modalities, including antibodies and ADCs.\n\nIn addition, the highly differentiated core capabilities can provide novel reagent generation, proprietary assays and then silico capabilities that can also support OmniAb discovery programs and can be accessed by partners when pursuing ion channels and transporter targets in a variety of approaches. Our Omnia technology platform creates and screens diverse antibody pools, and is designed to quickly identify optimal antibodies or related candidates for our partners, drug development efforts. We harness the power of biological intelligence or what we call BI, which we have built into our proprietary and validated transgenic animals and pair with our high throughput screening technologies to enable the discovery of high quality, fully human therapeutic candidates.\n\nThese high quality antibodies are naturally optimized in our validated host systems for affinity, specificity, developability and functional performance. Our partners realize that they have access to antibody candidates that are based on unmatched biological diversity and are optimized through integration across a full range of technologies, including antigen design, transgenic animals, deep screening and characterization and proprietary assays. And importantly, our technology can be leveraged to develop multiple therapeutic formats, including mono, buy and multi-specific antibodies, antibody, drug conjugates, or ADCs, and CAR-T therapies.\n\nWe can provide our partners both integrated and end capabilities and highly customizable offerings, which address critical industry challenges and provide optimized discovery solutions. Over 50 partners have access to OmniAb derived antibodies with over 200 active discovery programs and now as of today, including 20 OmniAb derived antibodies in clinical development and also including an approved product as I referenced earlier and I'll finish by saying that we see the potential for a very bright future for OmniAb ahead.\n\nAnd with that, I'll turn the call back over to the operator for questions. So Eli, I'll turn it back over to you.\n\nOperator\n\nThank you, Matt. [Operator instructions] And for your first question, we have from the line of Larry Solow from CJS Securities. Your line is now open.\n\nLarry Solow -- CJS Securities -- Analyst\n\nGreat guys. Thanks so much for taking the questions and good evening. I guess the first question I have is just on the announcement I guess, somewhat a surprise, but I know you guys have been sort of exploring options for a while and John, you touched on sort of why now, but is it sort, it seems like it's sort of the culmination of these things, both the market has certainly had several sort of public companies out there with somewhat similar technology, but also company specific guys have built a lot of add on and whatnot.\n\nSo I'm just trying to assess, is it, was there some inflection point that OmniAb specific that brought you to this timing this decision or a little more color on that would be great and any way to what you think of in terms of valuation? I know you guys have thrown out a number a couple years back, and I don't know if those, if you can discuss that, but, it was probably more higher value than what your whole company's value today. So just trying to assess those thoughts.\n\nJohn Higgins -- Chief Executive Officer\n\nLarry, thank you. I'll answer your first question then Matt Korenberg can comment on process evaluation. So the business, people who know Ligand know this leadership team. I believe we're creative. We look at opportunities. Obviously we focus on excellent science and excellent partner relations. That is our craft, our core business, but when it comes to optimizing value, we're looking at M&A ways we can acquire and build. This is a very unique transaction in my experience at Ligand obviously we've never split the company but we're doing it as we've said in our have remarks with a sense of confidence and that this is the right decision at the right time. What's driving it is the success of the business and also a real belief that we have an opportunity here.\n\nThe success we've described across, the whole business we're doing well, but specifically as we look at the diversity and royalty, the royalty momentum, the new approvals, some recent acquisitions that is further supporting the royalty business, it's a great business. We are licensing technology, we're driving products and that business, the last three, four, five quarter has really emerged as a great growth position right now. The OmniAb business, it's not a surprise as in the last month or two what we have, but no doubt our decisions, our acquisitions to fortify that platform the partner success, the last, several quarters last year or so through the pandemic, especially we have emerged with confidence that we have got a very, very strong technology leading platform.\n\nSo it's out of success that we see this. We've got a board we've got management team. We have the resources to run two companies. The other part is if you have opportunity we believe by having focus teams that look at R&D investment, that look at capital allocation that can position focus compelling investor profiles for investors, we think the opportunity will better serve our investors to create and grow value out of two companies versus one combined. So that's where we are. We have been planning, there are different ways to do this, but with, I think a lot of thoughtful work and decision making, we feel very good about this circumstance. Matt, I'll let you comment on valuation.\n\nMatthew Foehr -- President and Chief Operating Officer\n\nYeah, thanks, John. And Larry that the valuation point we really can't comment on valuation, but I will just reiterate from what John said that I think in addition to all the good reasons that John gave, I think there's an opportunity for the new business to invest more significantly and in driving the long term value of that business, that might not be as overlapping with the short term EPS goals of the combined business. And so that's just another reason that we think the longer term value will be more significant as two separate companies. So I'll leave it there.\n\nLarry Solow -- CJS Securities -- Analyst\n\nYeah, no, fair enough. I think that would be a challenging question to answer, we put out there just on a follow up just Matt on the, just on the legacy business, existing business, and maybe just a global question, lot of good things happening in the quarter. You think KYPROLIS, EVOMELA obviously Remdesivir sales a lot higher than expected. Gilead increased guidance, but I think 50% for the year. I know that that is still tailing off and we actually don't have any numbers in there for 2022. But just in terms of Q4, how come seem like guidance would've been increased? Is there any particular reason why it wasn't?\n\nJohn Higgins -- Chief Executive Officer\n\nYeah. Good question Larry that the overall business is doing great. The royalty reports came in for KYPROLIS and EVOMELA quite well, but also I mentioned on my prepared remarks that both Teriparatide and Rylaze were quite strong and several of their smaller products that we don't of talk about a lot were quite strong as well. And so I think you'll start to see us breaking out some of the bigger products in addition in our quarterly filings so that you can start to track some of the other individual products beyond just KYPROLIS and EVOMELA and that's really something that we're excited about. So those products become top of the royalty chart contributors for us.\n\nBut on the overall business, I'd say our core business is performing extremely well. All three lines of business royalties, contract payments and the Captisol sales from a core standpoint and the core legacy customer base are all performing quite well and we see really nice growth in the next year in the Q4 and into next year. We didn't change guidance for this quarter largely because the Captisol related to Remdesivir is still unknown to us generally speaking, in terms of where exactly it'll land this quarter versus next quarter. We're shipping significant amounts still. So some of that may, may spill into next year may be in this year. But generally speaking each of the parts of the business that we sort of have a better handle on a more control over all performing ahead of expectations.\n\nLarry Solow -- CJS Securities -- Analyst\n\nOkay. Fair enough. Thanks. I appreciate that call.\n\nOperator\n\nYour next question is from Matt Hewitt-Craig-Hallum Capital Group. Your line is now open.\n\nMatt Hewitt -- Craig-Hallum Capital Group -- Analyst\n\nGood afternoon, gentlemen. Congratulations on the strong quarter. First one, regarding that the COVID 19 pill that you recently out licensed. Do you have any sense how quickly that could move into the clinic and how you're thinking about that potential opportunity?\n\nJohn Higgins -- Chief Executive Officer\n\nYeah. Thanks Matt. We announced a collaboration with Chinese resources Double Crane around our vPro technology, which is a proprietary pro drug technology. It's based around a COVID 19 antiviral treatment and oral treatment. Difficult to say exactly when it may enter the clinic. It's great we've got a very dedicated partner who's highly focused on it, but obviously it's a preclinical program at this stage.\n\nMatt Hewitt -- Craig-Hallum Capital Group -- Analyst\n\nOkay, great. Thank you. And then kind of sticking along those tracks, I'm looking ahead to next year, is there the potential for any additional drugs that use that vPro technology to be outlicensed?\n\nJohn Higgins -- Chief Executive Officer\n\nWe're always cautious not to promise licensing deals. We will direct you. There are more datasets related to vPro and related technologies coming out at the ASLD conference. So would generally direct you there. But yeah, there's definitely applicability of the platform across other active ingredients as well.\n\nMatt Hewitt -- Craig-Hallum Capital Group -- Analyst\n\nOkay. And then one last one for me, and then I'll hop back in the queue, early on with the success of Remdesivir Veklury, you commented and I can't remember which quarter it was, but you commented on the record number of sample requests that you had received and as time has gone on, I'm just curious if you have seen, I guess, either follow on orders, if you've seen some of those projects or customers maybe blossom into the next stage of potential development, all because of what happened with Remdesivir in the early days. Thank you.\n\nJohn Higgins -- Chief Executive Officer\n\nYeah, Matt it's John, good question. We've had inbound inquiries more licensing and research sampling but we're focusing on the major value drivers right now for investors. So we aren't spending time tracking those on earnings calls at this time.\n\nMatt Hewitt -- Craig-Hallum Capital Group -- Analyst\n\nUnderstood. All right. Thank you.\n\nOperator\n\nNext we have Jacob Jacob Johnson from Stephens. Your line is now open.\n\nJacob Johnson -- Stephens -- Analyst\n\nHey thanks. Good afternoon. Congrats on a nice quarter, just on the OmniAb news. Can you just talk about the timeline for potentially deciding to IPO OmniAb, maybe just any kind of brackets for how we should think about the timeline for that. And then I don't know if you can, but can you just maybe discuss what other options are on the table, because I think you alluded to maybe there being other options out there as well.\n\nMatthew Foehr -- President and Chief Operating Officer\n\nSure. yeah. Thanks Jacob. So generally speaking we've talked with investors over the last couple years about ways to monetize value around the OmniAb business concepts like selling 10% of the business for economics just the economics of the business to some investors or minority investments in the business or collaborative -- strategic collaborations or things we've all talked about, and John already went through sort of the list of factors why we came to the conclusion that now is the right time to be more aggressive about separating the companies. So with that, I think, we have been and will be open to sort of all potential path forward. Probably one that's -- it's on investors' minds are the spec market.\n\nThere are certainly some potential spec transactions that have happened that could be very analogous to what we're trying to do here with OmniAb. And that's something that we have and will continue to explore, but based on everything we've seen so far the path to the best path we think right now to two independent public traded companies is the traditional IPO path followed by a separation through a spinoff of the remaining interest. And so I think that's generally the path that we expect to proceed down.\n\nObviously if circumstances change we are open and nothing's been definitively decided yet, but that's generally the path we're on. In terms of timing, look, we are not committed to specific timing. We'll continue to pursue the path as sort of expeditiously as prudent. I think we're hoping to file an S1 sometime in the coming months, if not in the near future. And then look to for next year to consummate a transaction sometime next year. So it's not something that's years out, but it's not something that's going to happen, certainly not happen in calendar 2021.\n\nJacob Johnson -- Stephens -- Analyst\n\nGot it. Thanks for that, Matt. And then just maybe sticking on OmniAb, I think the last couple quarters you talked about kind of a number of investments in that business. I think it includes things like maybe providing more customized services to partners. Can you just talk about some of the efforts at OmniAb recently where you've been kind of spending opex there?\n\nMatthew Foehr -- President and Chief Operating Officer\n\nYeah. this is Matt Foehr, clearly we've built the OmniAb business through, not only I'll say focused and strode acquisitions of adjacent technologies, but also through internal investment. And we see growing trends in the industry around partners coming to us and needing more technology. They certainly understand the value, not only of the depth of engineering behind our transgenic animals, but also through our screening technologies, our are really bespoke capabilities around ion channels, which are commonly seen as very high value targets. But we've continued to invest not only in keeping our technology on cutting edge, but also continuing to invest in the integration of the technology within the different pieces of our stack. And all of those things are things that drive partner use.\n\nOur partners, we see more and more partners using our technology broadly. We just had another one start a clinical trial yesterday, which brought our number of clinical OmniAb antibodies up to 20 which is always good to see, and we see growth in the number of patents that our partners are filing for OmniAb derived antibodies being the primary invention, of course, and that creates a very long royalty tail long term. So a lot of efficiency in the business itself, but also we see a lot of opportunity as we continue to invest in keeping it on the cutting edge.\n\nJacob Johnson -- Stephens -- Analyst\n\nGot it. Super helpful. I'll leave it there.\n\nOperator\n\nNext we have Scott Henry of ROTH Capital. Your line is now open.\n\nScott Henrt -- ROTH Capital -- Analyst\n\nThank you. Good afternoon. You guys have certainly been very busy. A couple questions, I guess, first on Captisol, we're now into November. I know expectations have been low as far as a COVID take into 2022. Given where we are now, three months later than the last quarter, what are your thoughts on there perhaps being a little larger tail for Captisol going into 2022 than perhaps expected prior? Thank you,\n\nJohn Higgins -- Chief Executive Officer\n\nScott. Our outlook is unchanged. Obviously our guidance for this year is unchanged. The Captisol had been a big driver of revenue this year. No surprise of course, with our major contributions but our outlook really is unchanged or three months further along. You're right about that. As expected some other oral antiviral, some treatments have come along good data now approvals. The vaccines are still holding up very well. There's abundant supply and vaccine rates are going up. Obviously we're watching case rates US and internationally in the major commercial markets, case rates are coming down, hospitalizations and death rates are coming down.\n\nAnd there is growing narrative from Scott Gottlieb and other thought leaders that the pandemic really is moving along. We're hopeful for human high help that's the case specific to our partnership with Gilead. We will be there, we will continue to supply, but our outlook is really the focus on our core business. The 60 or 70 customers that are buying Captisol for other products for their clinical use, we're going to get back to really focusing on our core Captisol revenue and if there's a chance to supply Gilead in the consortium for remdesivir, we will but we do expect it's going to subside and be a smaller, smaller contributor going forward.\n\nScott Henrt -- ROTH Capital -- Analyst\n\nOkay. Thank you. Shifting gears, the royalty line even, we can kind of put in KYPROLIS numbers. We don't have Ono, but we can kind of assess that. And then adding a very strong evomela number there's still a pretty big delta to getting to total royalties. Were there any, stocking orders for some of the new products, just trying to get a sense of, where some of that significant upside is coming from in the third quarter?\n\nJohn Higgins -- Chief Executive Officer\n\nYeah. good, good question, Scott. Like you said, the math is pretty easy on KYPROLIS and EVOMELA and the previous sort of other bucket used to be, pretty steady, growing nicely every quarter, but pretty predictable. The new products from the Pelican acquisition are quite performing quite well. So I think like I mentioned in earlier in the call, we won't break it out in this queue, but probably in either the next queue or starting next year as we start to have comparable numbers for these different royalty lines, I think you'll see that the biggest contributor this quarter was Teriparatide from Alvogen. And then both the Serum Institute and the Jazz Riley's program both were meaningful contributors to the quarter as well. So those three programs probably account for all the difference that you can't back into from published and no numbers.\n\nScott Henrt -- ROTH Capital -- Analyst\n\nOkay, great. Thank you. That helpful. Final question, just on Teriparatide should we still be thinking about that PE rating coming in 2022? Does that still look like a likely occurrence?\n\nJohn Higgins -- Chief Executive Officer\n\nYeah. Scott, this is Matt Foehr. We don't -- as we said in the last quarter, we don't see PE happening this year. So that's obviously been discussed and disclosed. Alvogen as a partner, I'll say has a real strong and committed team managing the work toward TE and they've been in dialogue with the FDA and based on their discussions with the FDA they're performing some additional tests that they've coordinated with the FDA on.\n\nSo they're doing that work. We expect they'll submit that work sometime in the near future. And there's not a typical PDUFA timeline for this sort of thing, but we do -- we are continuing to monitor it and I'll say we've got a very committed partner who's highly focused on getting TE as soon as they can. We don't see that happening this year, but they're very committed to it.\n\nScott Henrt -- ROTH Capital -- Analyst\n\nOkay, great. I thank you for the color and thank you for taking the questions.\n\nOperator\n\nAnd there are no further questions at this time. That concludes the Q&A session.\n\nI will now turn the call back to John Higgins for closing remarks.\n\nJohn Higgins -- Chief Executive Officer\n\nYeah. Thank you. Yeah, just a quick remark. Appreciate the turnout and the call today. Good questions. We're very pleased with the business. It's truly an exciting time to be at Ligand. We've grown significant in laboratory operation, in headcount and staff. I want to acknowledge our team. It is A Plus. We're doing great science and research. We're answering some major world health questions and challenges and really, I think providing outstanding service to our partners, all with the focus of bring a great company for investors.\n\nSo want to acknowledge that the support of our board. They've been highly engaged, obviously substantial, strategic planning and work underway. We are confident in our decision making. We have clarity on our path forward and feel very good about the team in place and our future. So thank you, appreciate the time and we will keep you posted as our business evolves.\n\nOperator\n\n[Operator Closing Remarks]\n\nDuration: 45 minutes\n\nSimon Latimer -- Investor Relations\n\nJohn Higgins -- Chief Executive Officer\n\nMatthew Korenberg -- Executive Vice President of Finance and Chief Financial Officer\n\nMatthew Foehr -- President and Chief Operating Officer\n\nLarry Solow -- CJS Securities -- Analyst\n\nMatt Hewitt -- Craig-Hallum Capital Group -- Analyst\n\nJacob Johnson -- Stephens -- Analyst\n\nScott Henrt -- ROTH Capital -- Analyst\n\nMore LGND analysis\n\nAll earnings call transcripts\n\n"}
{"id": "000f272a-569a-45fd-9ca6-f933d072c022", "companyName": "SiTime Corporation", "companyTicker": "SITM", "quarter": 2, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/04/sitime-corporation-sitm-q2-2022-earnings-call-tran/", "content": "SiTime Corporation\u00a0(SITM -2.88%)\nQ2\u00a02022 Earnings Call\nAug 03, 2022, 5:00 p.m. ET\n\nOperator\n\nGood afternoon, and welcome to SiTime's second quarter 2022 financial results conference call. [Operator instructions] As a reminder, this conference call is being recorded today, Wednesday, August 3, 2022, I would like to turn the call over to Brett Perry of Shelton Group investor relations. Brett, please go ahead.\n\nBrett Perry -- Investor Relations\n\nGood afternoon, and welcome to SiTime's second quarter 2022 financial results conference call. On today's call from SiTime are Rajesh Vashist, chief executive officer; and Art Chadwick, chief financial officer. Before we begin, I'd like to point out that during the course of this call, the company may make forward-looking statements regarding expected future results, including financial position, strategy and plans, future operations, the timing market and other areas of discussion. It's not possible for the company's management to predict all risks, nor can the company assess the impact of all factors on its business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements.\n\nIn light of these risks, uncertainties and assumptions, the forward-looking events discussed during this call may not occur and actual results could differ materially and adversely from those anticipated or implied. Neither the company nor any person assumes responsibility for the accuracy and completeness of the forward-looking statements. The company undertakes no obligation to publicly update forward-looking statements for any reason after the date of this call to conform the statements to actual results or to changes in the company's expectations. For more detailed information on risk associated business, we refer you to the risk factors described in the 10-K filed on February 25, 2022, as well as the company's subsequent filings with the SEC.\n\nAlso during this call, we'll refer to certain non-GAAP financial measures, which we consider to be an important measure of company performance. These non-GAAP financial measures are provided in addition to, and not as a substitute nor superior to, measures of financial performance prepared in accordance with U.S. GAAP. The only difference between GAAP and non-GAAP results is stock-based compensation expense and related payroll taxes.\n\nPlease refer to the company's press release issued today for a detailed reconciliation between GAAP and non-GAAP financial results. With that, it's now my pleasure to turn the call over to Rajesh. Please go ahead.\n\nRajesh Vashist -- Chief Executive Officer\n\nGood afternoon, and thank you for joining us on today's SiTime call. While the focus of today's discussion is on Q2 results and Q3 forecast, I want to begin with the transformation of SiTime as a result of the acceleration in electronic macro trends, such as high bandwidth communications, cloud, EV and IoT. Here, precision timing products are defined as high-performance, small size and power efficient under demanding environmental conditions such as vibration, shock and temperature, are becoming the solution of choice. While precision timing is used significantly in comms enterprise, their use is growing in automotive and certain mobile IoT consumer applications.\n\nAs a creator of the category of precision timing, SiTime plays a central role in this transformation. As we transition from our legacy non-precision timing products and design wins into this transformation, SiTime will get significantly higher ASPs, more design win stickiness and a discussion of architecture with our customers. On Q2, SiTime had a banner Q2, we delivered record revenues of $79.4 million, non-GAAP gross margin of 66.7% and non-GAAP EPS of $1.11, all exceeding our previous guidance. This was our 11th consecutive quarter to do so.\n\nIn Q2, we had the highest ASPs in the history of the company, 30% higher year-on-year and 10% higher quarter on quarter. This came from the role of greater precision timing products in our revenue. While multiple segments contributed to this growth, our comms enterprise business was a standout. It grew 16% over Q1 and was the segment of the highest growth rate.\n\nMultiple customers in this application, such as network interface cards or NICS, data center servers and 5G wireless contributed to this growth, and we believe that the trend will continue in the second half. A common theme among these customers and applications was the use of our precision planning products to get a better system performance. As an example, one of these products, Elite, doubled in unit shipment from Q1 to Q2. And additionally, our precision timing opportunities have now grown to be 70% of our funnel.\n\nAutomotive was the segment with the second largest growth despite some customer pushouts due to industrywide supply chain issues. SiTime's previous success in ADAS computers, domain controllers and cameras continued, and we have begun to see volume ramping from newer applications as well, such as driver monitoring systems and LiDAR. As we know, the automobile is being transformed and new functionality in sensing, computing and communications is continuously being added. Getting this functionality to work in the presence of [Inaudible] temperature extremes is a difficult challenge, but one that can be solved and is solved by precision timing products from SiTime.\n\nThis is a natural place for SiTime to deliver value and grow, and we remain on track to deliver $100 million in annual automotive revenue in the next few years. In May, when we increased our guidance from 35% to 50% annual growth, we did not anticipate the subsequent conditions financial downturn, supply chain disruptions and political turmoil, all of which made it difficult for our customers to see the magnitude and the speed of decline in their own business. This is evident in our mobile IoT consumer segment, that is those that place lower value on the benefits of precision timing. Excluding our largest customer, the mobile IoT consumer segment is expected to be down by more than 30% in the second half of 2022.\n\nConsidering our end customers' visibility, we are, therefore, now comfortable with our earlier guidance of 35% annual growth for 2022. In line with that, we will manage our expenses prudently in the second half of this year. But our original thesis remains intact. We firmly believe that our longer-term top line growth will be 30% or more driven by the SAM expansion to $4 billion, the greater need for precision timing and fulfillment of those needs uniquely by SiTime.\n\nWe also continue to see a long-term financial model of 65% gross margin and 30% net income as being intact. We continue to invest significantly in the development of new precision timing products. In 2022 itself, we will sample six of these oscillators and clocks. These address the macro trends that I referred to that are transforming electronics, high-bandwidth communications, cloud, EV and IoT.\n\nWith these, we are confident in our ability to transform the electronics industry driven by greater adoption of these products. We expect that the stellar comms enterprise performance will continue into the second half with the volume ramping up of applications like 400G, 800G optical modules and data center switches. In our last call, we talked about a clock family with 200 customers by the end of '22, and that strength continues. 60% Of the Cascade, the clock family, revenue in '22 and '23 will now come from midcars, 5G RRU, and backhaul.\n\nOur investment in this segment is working. In 2022, comms enterprise is expected to grow to over 25% of our revenue compared to 16% last year in 2021. For example, again, our Elite product is expected to grow three times in revenue over 2021. The value and uniqueness of SiTime products is also clearly on display at our largest customer, which is in the mobile IoT consumer segment.\n\nOur revenue here continues to grow strongly in the second half of 2022, and the design win funnel continues to grow strongly as well. In the previous call, we have spoken about the strength of aero defense business. We're now engaged with the top defense contractors worldwide and our funnel continues to grow as they discover the strength of our unique precision timing products. The uniqueness of these SiTime products comes from the uniqueness of SiTime technology.\n\nWe've always maintained that our MEMS, analog circuits and the systems, putting it together to deliver a system solution is hard to do. In the past decade, we have not seen a credible competitor that is using similar technologies, and we don't see one on the horizon currently. A great advantage for SiTime during the turmoil of the past two years has been the flexibility and the solidity of our supply chain. We've made great inroads with customers because our supply chain has been proven to be superior to that of our existing -- to that of the existing suppliers in the market today.\n\nThat strength continues due to the support of TSMC, Bosch and our OSAT partners. Given that a majority of our customers are single sourced, our supply chain strength continues to be a competitive advantage for SiTime. In conclusion, as a category creator of precision timing, SiTime is uniquely positioned to transform this industry. We believe that our long-term growth and market share gains will continue unabated in the future.\n\nWith that, I'll now turn it over to Art Chadwick, our CFO.\n\nArt Chadwick -- Chief Financial Officer\n\nGreat. Thanks, Rajesh, and good afternoon, everyone. Today, I'll discuss second quarter results and provide some comments on Q3 and the year. I'll focus my discussion on non-GAAP financial results and refer you to today's press release for a detailed description of our GAAP results, as well as a reconciliation of GAAP to non-GAAP results.\n\nSo as Rajesh mentioned, Q2 was a record revenue quarter for us. Revenue was $79.4 million, up 13% sequentially and up 78% over the same quarter last year with exceptional strength in our higher-end, higher-performance products. Sales into our mobile IoT and consumer segment, which consists of sales into mobile phones, wearable devices and consumer products, were $27.0 million or 34% of sales, down 10% sequentially, but up 24% over the same quarter last year. Sales to our largest end customer, which are included in this segment, accounted for 14% of total sales.\n\nSales into our industrial, automotive and aerospace segment, which includes sales into automotive, industrial, medical, aerospace, military and broad-based sales were $32.2 million, or 41% of sales, up 17% sequentially and up 137% year over year. Sales into our communications & enterprise segment, which consists of wireless infrastructure, 5G, data center and networking were $20.2 million or 25% of sales, up 60% sequentially and up 120% over last year. Non-GAAP gross margins were strong at 66.7%, up 140 basis points from Q1 and up more than five points over the same quarter last year. Non-GAAP operating expenses were $28.3 million, a 15% sequential increase over Q1 as we expanded our workforce and increased investment in new product development.\n\nExpenses were $16.7 million in R&D and $11.5 million in SG&A. Non-GAAP operating margins were 31.1%. Non-GAAP net income was $25.3 million or $1.11 per share. This is up from $21.3 million or $0.94 per share in Q1 and up from $9.6 million or just $0.46 per share in the same quarter last year.\n\nStock-based compensation expense decreased from $15.2 million in Q1 to $12.5 million in Q2, as we adjusted stock comp expenses related to some internally granted performance RSUs. Receivables were $38.7 million with DSOs of 44 days, and inventory was $34.4 million, up from last quarter as we continued to increase wafer buffer stock. In regard to cash flow, we generated $15.3 million in positive cash flow from operations, invested $9.6 million in equipment and assets and ended the quarter with $580 million in cash and no bank debt. I'd now like to provide some comments on Q3 and the year.\n\nFirst of all, we believe our long-term strategy of developing and selling higher performance products into markets that require ever more precision timing is strongly intact. However, the current macroeconomic environment is impacting sale of some of our products and especially our lower-end products. At the beginning of this year, we thought 2022 revenue would increase by at least 35%, which we discussed on our conference call in early February. Three months later, we were more optimistic.\n\nAnd in early May, we voiced our opinion that 2022 revenue could increase by at least 50%. That view is based on then current order rates and were supported by our internal forecast. However, the current economic environment now appears somewhat less certain and order rates this summer have slowed, especially from our lower-end products. We have, therefore, modified our revenue expectations for the year and now believe 2020 -- excuse me, 2022 revenue growth will be closer to our previous 35% estimate.\n\nAs a result, sales in the second half of this year will be essentially flat with sales in the first half. However, product mix will improve significantly. We now expect sales in the second half of the year into consumer and IoT will be down 30% or more from the first half, not counting sales to our largest customer. Sales in the broad-based industrial will also be down, but to a lesser extent.\n\nHowever, we expect those declines will be offset by increased sales to our largest customer, and a 30% or more increase in sales in the comms and enterprise. For Q3, we expect sales will decline between 6% and 10% sequentially due primarily to lower consumer sales. At the midpoint, this would be approximately $73 million or 16% higher than the same quarter last year. We expect Q3 gross margins will remain strong at about 65%, plus or minus one point.\n\nQ3 operating expenses would have increased due to the workforce additions in Q2. But we are aggressively managing discretionary costs to maintain Q3 opex at Q2 levels or approximately $28.3 million, plus or minus. Fully diluted share count will be approximately 23 million shares in Q3. So this guidance just provided -- should drive a non-GAAP EPS of between $0.80 and $0.90 per share in the third quarter.\n\nAnd on that note, I'd like to turn the call over to the operator so we can begin our Q&A. Thank you.\n\nOperator\n\nThank you. [Operator instructions] OK. We have Tore Svanberg.\n\nTore Svanberg -- Stifel Financial Corp. -- Analyst\n\nYes, thank you. First question is on your comment about order rates slowing. I think there's no surprise that consumer and IoT is slowing. I'm a little bit surprised to hear the industrial and defense category seeing some lower orders.\n\nSo can you just elaborate a little bit about what's going on there? Were there perhaps some inventories built in the first half of the year? So any color you can share that -- there would be great.\n\nRajesh Vashist -- Chief Executive Officer\n\nTore, thanks. Yes, I think, as you said, it's not a surprise that mobile IoT consumer were down. But in the industrial, I don't think automotive or aerospace has much changed. Aerospace and automotive continues strong.\n\nThere have been some pushouts in automotive, but they were more than offset by growth from other customers. The industrial is our sort of catch-all phrase. It's our largest group of customers. And the distinction that I want to make is that it has less to do with the end customer and has more to do with those that are using precision timing products for the purpose that they were intended or not.\n\nSo as an example, in the consumer space, our largest customer is using precision timing products for their very high-end products, and those very high-end products continue unabated as opposed to some of their competitors, where we also sell -- where they have seen significant downturn. So the similar thing happened in some industrial customers where they probably found either a pushout, which is more likely of their inventories because of higher inventories. We likely have not lost many design wins, but there have been pushouts and they have been a smaller impact because of not being able to source other components. And that would typically be the case with industrials because they typically tend to be smaller customers, not larger customers.\n\nAnd they would not be in the priority list for getting other components as well.\n\nTore Svanberg -- Stifel Financial Corp. -- Analyst\n\nFair enough. And I know you've been working on your sales strategy and certainly getting a wider reach with customers. And I know you announced the SiTime direct online store recently. Could you elaborate a little bit on that? And when should we start to expect a contribution from that particular business model?\n\nRajesh Vashist -- Chief Executive Officer\n\nYes. So we should be able to start expecting that starting this year. I think you'll see greater and greater traction for that for 2023 and onwards. We've just really begun this e-commerce strategy right now.\n\nIt's very much in its nascent stages. And we think that part of the task of SiTime is to grow from 14,000, 15,000 customers to about 30,000, 40,000, 50,000 customers in the coming years. And the e-commerce strategy has a lot to do with it. It's part of our broad-based strategy.\n\nIt is part of expanding our customer base. One of the things we find, Tore, is that the more we dig, the more we find. We find that some of these customers have an extreme need for these precision timing products. And typically, they are smaller customers that don't -- they have enough help in designing these.\n\nOur products make it easier for them to get the job done. And as you know, we sell at a premium, but they're willing to pay that premium. So I fully expect that that strategy will lead to higher than corporate gross margins and much greater stickiness because we solved a significant problem for the customer. So stay tuned for more on that as we go forward.\n\nTore Svanberg -- Stifel Financial Corp. -- Analyst\n\nGreat. Just one last one for Art. Gross margin, 65%, why wouldn't it be higher given the favorable mix for the second half of the year, especially with the mobile consumer being a much lower percentage of the business?\n\nArt Chadwick -- Chief Financial Officer\n\nYes, excellent question. So there is potential upside to that. But you also have to remember with the lower top line revenue our manufacturing overhead becomes a larger percentage of sales. So that kind of counteracts that to a certain extent.\n\nAnd sales to our largest customer will increase in the second half over the first half, including Q3. And I don't want to go into specific margins, but that also can have some impact on our gross margins.\n\nTore Svanberg -- Stifel Financial Corp. -- Analyst\n\nGreat. Thank you so much.\n\nArt Chadwick -- Chief Financial Officer\n\nGreat. Thanks, Tore.\n\nOperator\n\nNext, we have Alessandra Vecchi from William & Blair.\n\nAlessandra Vecchi -- William Blair and Company -- Analyst\n\nHi, guys. Just a follow up on Tore's question, maybe taking it from a slightly different angle. Again, I think we all understand the weakness in mobile consumer. But can you help clarify at what point you really start -- you start to see that sort of nose dive off? Was it later in the month of June that it really started to deteriorate? And then similarly, if my math is correct, it looks like that the Q3 consumer number is the lowest number since the first half of 2020.\n\nSo how much of that is not precision timing kind of a code word for some of the supply chain wins you might have won during the COVID time frame and how we should think about the levels recovering in 2023 from here?\n\nArt Chadwick -- Chief Financial Officer\n\nYes. So in terms of the time frame, is really this summer, where we've seen order rates drop rather surprisingly and substantially, kind of very end of Q2, certainly in the month of July. And I think it surprised a lot of folks, including us. But again, it's really our lower-end consumer products, and it does not impact our largest customer in that segment.\n\nSales to our largest customer in that segment and of course, our largest customer as a company, we expect will increase actually nicely from the first half to the second half of the year.\n\nRajesh Vashist -- Chief Executive Officer\n\nAnd then, to add to that, I would say that what was also surprising was that while we were in touch very close communications with our top customers all across the world, many of them were not able to -- to understand the magnitude of some of this buildup, not just in the consumer, but in some of the other markets as well. And I think that we are early in our ability to foresee that the downturn has some particular influence on Q3. So I think that that's an important piece here to note, that we were kind of surprised by the surprise that the customers had and their inability to lead.\n\nAlessandra Vecchi -- William Blair and Company -- Analyst\n\nOK. And then, as an extension of that, on the inventory dollar creep up, again makes sense given some of the maneuvers you've done in securing capacity. But given the slowdown to revenue growth in the back half, how should we think about inventory levels from here? Are you going to work them down? Are they still below target levels?\n\nArt Chadwick -- Chief Financial Officer\n\nYes. So I did mention that our inventory went up about $4 million in Q1 to Q2. That is a very conscious decision. I think most folks realize that the entire semiconductor industry was in very tight supply, including us.\n\nWe always have enough to ship the demand that we had, but we've made a conscious and strategic decision to build some buffer stock, especially with wafers. In case there are any disruptions in the supply chain, a lot of things can happen in the world that could impact the supply of wafers, we want to make sure we've got sufficient supply to handle any intermittent disruption. So I expect that inventory will go up more, not substantially, but it will go up more. We will increase our buffer stock between now and the end of the year.\n\nAnd I think that's the right prudent thing to do. We have a lot of cash in the bank. We earn a little bit of money on it. Wafers do not go bad.\n\nSo building a little more inventory, I think, is actually a very smart business move on our part because we have the ability to do that both on a cash basis and because of the relationship we have with our wafer fabs.\n\nRajesh Vashist -- Chief Executive Officer\n\nAless, it goes back to the single source given that's such a large portion of the business, single source, it's prudent for us to secure particularly wafers and build wafer inventory, because remember that our product is programmable. So that programmability gives us a significant amount of flexibility in our supply chain.\n\nAlessandra Vecchi -- William Blair and Company -- Analyst\n\nUnderstood. With that, I'll go back in queue. Thank you so much.\n\nArt Chadwick -- Chief Financial Officer\n\nThanks, Aless.\n\nOperator\n\nOur next question comes from Suji Desilva from Roth Capital.[Audio gap]\n\nRajesh Vashist -- Chief Executive Officer\n\nSo it's harder to tell. There's everything in there. There's some medical in there, which is clearly precision timing. There's some high-end industrial in there, which is clearly precision timing.\n\nAerospace, auto -- so all of those, it's just that, I think, that there are myriad of customers may be perhaps more based in China which had some impact in that market. And again, we haven't lost anything because of design win losses or because for that matter of ASP losses either, even though the competitive solution is much more easily available right now than it was three, four months ago. But still, we haven't lost anything there.\n\nQuinn Bolton -- Needham and Company -- Analyst\n\nI guess that was going to be my next question, Rajesh, as you've seen, sort of, customers at the lower end, slowing orders to adjust inventories, can you give us a sense how many of those sockets are truly sole sourced by SiTime? And you're sort of confident that when that inventory purge is complete, you'll see the orders rebound versus sockets, which may be dual sourced. And so, there might be a risk that after the inventory purge, they could come back at just an overall lower level of demand given increased supply from competitors where the mix might move back to more of a dual sourcing strategy. Is there any way to try to quantify that?\n\nRajesh Vashist -- Chief Executive Officer\n\nYes. Well, let me take a stab at some of it anyway. And that is that even when a customer has a second source, when we did, we sometimes find that that's \"more of a theoretical thing\". It's really -- it takes them still three months to six months to do a qualification.\n\nTypically, that incentive is low. What happens more is as it happened at one customer where we were on a particular design win, and it was an older design win. And they just decided that, you know what, with the slowdown that they were facing, why don't we end-of-life this product? And so, they just end of life it and they moved customers over to a different product that they had. So I think when the supply chain has been hyper tight like it has been, and then when it opens up, like it is mostly opening up, customers start to look at that and say, wait a minute, what should -- else should I do different? As far as the socket itself, I think our single-source sockets are generally pretty solid.\n\nI don't see them getting away from us based on, \"Oh, I'm just going to stop somebody else for a few cents.\" We don't see -- we haven't seen too much of that or in fact, I haven't personally seen any of that. I've seen more around pushouts and I've seen certainly some in automotive and in the very high-end industrial where people have not been able to get other products to build out. And so, they just -- they're just sort of sitting there and saying, \"we'll just wait\". This has happened in, for example, in batteries, in electric motors.\n\nMany of these customers are relatively smaller customers in size. They're not the big multibillion-dollar companies. And so, they're almost always the last ones to get all the other components as well. I don't know if that's helpful.\n\nQuinn Bolton -- Needham and Company -- Analyst\n\nNo, that's very helpful. And maybe if I could summarize just hopefully I have the right picture. If I think about precision timing, it sounds like that's at least 60%, maybe as high as kind of the less demand there has been pretty solid for the lower end. You're seeing what you think is mostly just sort of inventory adjustments leading to lower order rates, but you haven't seen significant moves perceiving at the low end, it's just a traditional inventory purge and maybe it takes a quarter, maybe it takes two, but you're pretty confident of keeping even those low-end sockets as demand comes back post the inventory clearing.\n\nRajesh Vashist -- Chief Executive Officer\n\nYes. And the other side of that is it gives an acceleration to our precision timing products because now they're starting to become greater and greater portion of our revenue and certainly a much greater portion of our funnel, which is exactly what we talked about a couple of years ago that this is the direction we want to go in. We're just sort of accelerating into that with the current -- over the current trend.\n\nQuinn Bolton -- Needham and Company -- Analyst\n\nGot it. Thank you.\n\nArt Chadwick -- Chief Financial Officer\n\nGreat. Thanks, Quinn. Tore, did you have another question? Operator, are there any other questions? Operator?\n\nOperator\n\nNo, there are no additional questions at this time.\n\nArt Chadwick -- Chief Financial Officer\n\nOK.\n\nOperator\n\nSo at this time, I'm going to turn it over to the speakers for any closing remarks.\n\nArt Chadwick -- Chief Financial Officer\n\nAll right. Well, we want to thank everybody for joining us today. We apologize for the interruption in the call. We're not sure exactly what happened, but we'll go figure that out.\n\nI hope everybody had a great day. Thank you so much.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nBrett Perry -- Investor Relations\n\nRajesh Vashist -- Chief Executive Officer\n\nArt Chadwick -- Chief Financial Officer\n\nTore Svanberg -- Stifel Financial Corp. -- Analyst\n\nAlessandra Vecchi -- William Blair and Company -- Analyst\n\nQuinn Bolton -- Needham and Company -- Analyst\n\nMore SITM analysis\n\nAll earnings call transcripts"}
{"id": "00181605-3dfa-4b82-aa7b-45c5eaf45125", "companyName": "Ellington Financial LLC", "companyTicker": "EFC", "quarter": 3, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2021/11/08/ellington-financial-llc-efc-q3-2021-earnings-call/", "content": "Ellington Financial LLC\u00a0(EFC 0.15%)\nQ3\u00a02021 Earnings Call\nNov 8, 2021, 11:00 a.m. ET\n\nOperator\n\nGood morning, ladies and gentlemen, thank you for standing by. Welcome to the Ellington Financial Third Quarter 2021 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]\n\nIt is now my pleasure to turn the call over to Jason Frank, Deputy General Counsel and Secretary. Please begin.\n\nJason Frank -- Deputy General Counsel and Secretary\n\nThank you. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature. As described under Item 1A of our Annual Report on Form 10-K filed on March 16, 2021, as amended, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call and the company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.\n\nI am joined on the call today by Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, Co-Chief Investment Officer of EFC; and JR Herlihy, Chief Financial Officer of EFC.\n\nAs described in our earnings press release, our second quarter earnings conference call presentation is available on our website ellingtonfinancial.com. Management's prepared remarks will track the presentation. Please note that any references to figures in this presentation are qualified in their entirety by the end notes at the back of the presentation.\n\nWith that, I will now turn the call over to Larry.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nThanks, Jay, and good morning everyone. As always, thank you for your time and interest in Ellington Financial.\n\nI'll begin on Slide 3. During the third quarter, Ellington Financial generated net income of $0.41 per share and core earnings of $0.46 per share. So core earnings continue to cover our dividend. Through the first nine months of the year, we have now delivered an economic return of over 11% and a total return to stockholders of over 33%.\n\nNext, please turn to Slide 11. During the quarter, we significantly grew our proprietary loan portfolios as we deployed the capital from our common equity raise in July. We had our second consecutive record quarter for originations in our non-QM business, funding $297 million in the third quarter. And we also had our second consecutive record quarter for originations in our Residential Transition Loan or RTL business, funding $106 million in the third quarter as you can see here on this slide. Our RTL fundings actually grew more than 50% from the prior quarter. Within RTLs, the fix and flip business is a seasonal one, so I wouldn't expect us to see that kind of RTL growth for the next couple of quarters. But I'm hopeful that RTLs could be a big business for us in 2022. Overall, we grew our proprietary loan portfolios by 41% quarter-over-quarter to $1.26 billion. And keep in mind that the $368 million of growth was net of pay-downs.\n\nI was extremely pleased with the pace and quality of our capital deployment during the quarter. Our proprietary loan pipelines continued to provide us with a robust supply of high-yielding investments and we absorbed that supply with relative ease. The new capital was, both raised and fully deployed, all within the third quarter, and so we were able to avoid any material drag on core earnings. Looking ahead, the prospects for continued growth in earnings from our proprietary loan pipelines continue to be excellent. Thanks to its record origination volume during the quarter, our non-QM affiliate, LendSure, posted record profitability as well for the quarter. And thanks to our loan flow from LendSure, we were able to complete our third non-QM securitization of the year shortly after quarter end. This represented the ninth non-QM securitization that we've completed and we've now passed the $2 billion mark in total non-QM loans acquired from LendSure to date.\n\nThis cycle of non-QM acquisitions, followed by securitizations, has several important benefits for EFC. We reap the benefits of a high-yielding and, we believe, low risk asset class; we strengthen our balance sheet and enhance earnings, thanks to the superior long-term financing provided by the securitization market; and ultimately, we're able to manufacture highly attractive retained tranches at prices not available in the secondary market. Meanwhile, in addition to all the growth we're seeing in our residential mortgage loan businesses, we've also recently seen substantially increased loan flow in our small balance commercial mortgage bridge loan business. And last, but certainly not least, we have now closed on three additional strategic equity stakes in loan originators in just the last six months, and we have several others in the works that we hope to complete before year end.\n\nWith these additional strategic stakes, we're continuing to fortify our vertically integrated loan origination business, which continues to supply a consistent flow of high-quality, high-yielding assets underwritten to our specifications. Our relationships with our originator affiliates are symbiotic as we not only provide them with a reliable outlook for their production, but we also help them enhance their underwriting guidelines, we help them improve the terms and stability of their financing sources, and we help boost their overall visibility in the marketplace. I'm excited about these new strategic equity investments and I believe that they will further expand and diversify our proprietary loan pipelines.\n\nNow please turn to Slide 5 where you can see the net interest income in our credit strategies again led the way in the third quarter. This net interest income was driven by our growing loan portfolios, which, by the way, also continue to exhibit excellent credit performance. Our credit strategies also delivered significant net gains during the quarter, with significant contributions from our CMBS, CLO and non-Agency RMBS portfolios, together with the gains driven by our share of LendSure's record profits for the quarter.\n\nAs I mentioned, LendSure's third quarter was a record one, both for origination volume and earnings. LendSure originated $456 million of loans, which was a 39% increase from their second quarter's total of $326 million. LendSure is on pace to exceed, just in 2021, its origination volume for the prior two years combined, and critically, loan performance has continued to be excellent, even as origination volumes scale. Most of LendSure's growth so far has been in existing products and channels. But the LendSure team is working on amplifying its momentum by rolling out new products and channels and we're excited to see what 2022 will bring.\n\nI'll turn next to Longbridge Financial, our reverse mortgage originator affiliate. In the Agency reverse mortgage market, continued high levels of home price appreciation, together with low interest rates, have led to elevated pre-payment speeds as borrowers seek to refinance. In response to these higher speeds, we saw some acute downward repricing in the HMBS market, which is the market for agency reverse mortgage pools. While these market forces have boosted origination volumes for Longbridge, they also caused a decline in the value of long bridges portfolio of Mortgage Servicing Rights or MSRs. This drove an overall quarterly net loss for the company. But importantly, Longbridge's originations segment was still profitable during the quarter. As a result, we see this quarterly net loss as an anomaly for Longbridge. The company had a monthly record for origination volume in September and year-to-date, Longbridge is actually Number 3 in the industry in total HMBS issuance. Moving forward, we believe that Longbridge's earnings and growth prospects continue to be excellent. And in fact, the company has bounced right back to profitability in October.\n\nWith that, I'll pass it to JR to discuss our third quarter financial results in more detail.\n\nJR Herlihy -- Chief Financial Officer\n\nThanks, Larry, and good morning everyone. Please turn back to Slide 3 of the presentation. For the quarter ended September 30, Ellington Financial reported net income of $0.41 per share and core earnings of $0.46 per share. These results compare to net income of $0.75 per share and core earnings of $0.51 per share for the prior quarter. As a reminder, last quarter's core earnings reflected several small balance commercial mortgage loan resolutions, which included the payment of past due interest and recovery of previously paid expenses. Removing the idiosyncratic effects of those asset resolutions, our core earnings per share was roughly unchanged quarter-over-quarter and was actually slightly above the estimated core earnings run rate that we mentioned on last quarter's call.\n\nDuring the third quarter, we issued 6.3 million shares of common stock through a follow-on common stock offering in July. And we issued another 1.55 million shares of common stock through our at-the-market program. In total, we increased our equity by $141 million or approximately 15%. Importantly, the proceeds from these issuances were fully invested by the end of the third quarter.\n\nMoving to Slide 4, you can see that we finished the third quarter with just over 80% of our deployed capital allocated to credit strategies and 19% allocated to our Agency strategy, similar to how we were positioned last quarter. Our credit portfolio grew by 24% quarter-over-quarter, and I'll get into where that growth occurred shortly.\n\nNext, please turn back to Slide 5 for the attribution of earnings between our credit and Agency strategies. During the third quarter, the credit strategy generated total gross income of $0.66 per share, while the Agency strategy generated gross income of $0.03 per share. These results compare to $1.25 per share in the credit strategy and a loss of $0.03 per share in the Agency strategy in the prior quarter. We benefited from strong performance in most of our primary credit strategies during the third quarter. Our loan strategies, including non-QM, residential transition, small balance commercial mortgage and consumer generated high returns on equity, driven primarily by net interest income, while performance in the CMBS, CLO and non-Agency strategies -- non-Agency RMBS strategies were also excellent, driven primarily by net realized and unrealized gains. We also had successful resolutions on a couple of larger commercial mortgage NPLs and subsequent to quarter end, we closed on the sale of one of the largest commercial real estate REOs in the portfolio at a significant profit.\n\nOn the other hand, as Larry noted, Longbridge Financial incurred a net loss for the quarter, driven by mark-to-market losses on its MSR portfolio, which negatively impacted Ellington Financial's results. In Agency RMBS, performance was mixed during the quarter. In July and early August, interest rates continued to fall and volatility increased, causing Agency RMBS to underperform treasuries. Moving into the latter half of the quarter, interest rates began to increase and volatility declined, and toward the end of the quarter, Agency yield spreads tightened as the market got more clarity on the Federal Reserve's tapering plan. Incrementally higher mortgage rates, particularly in September, led to reduced expectations for pre-payment rates and boosted higher-coupon RMBS, while the anticipated withdraw of Fed purchases negatively impacted lower-coupon RMBS.\n\nNet interest income on our Agency portfolio, strong performance from our interest-only securities, and net gains on our higher-coupon specified pools exceeded net losses on our lower-coupon holdings and reverse mortgage portfolio. On the hedging side, net losses on TBA short positions, particularly on higher coupons, slightly exceeded net gains on interest rate swaps and U.S. Treasury hedges.\n\nTurning next to Slide 6. During the third quarter, our total long credit portfolio grew by 24% to $1.69 billion as we deployed proceeds from our July equity issuance. The vast majority of the growth occurred in the non-QM and residential transition loan strategies, which are both captured in the residential loans slice on this page. Our small balance commercial mortgage portfolio also grew, although opportunistic sales of CMBS, where we generated some significant gains, caused the overall commercial real estate slice to shrink sequentially.\n\nOn Slide 7, you can see that our long Agency RMBS portfolio also increased during the quarter by 4% to $1.54 billion as of September 30.\n\nTurning to Slide 8, our debt to equity ratio adjusted for unsettled purchases and sales decreased to 2.9:1 as of September 30 as compared to 3.2:1 as of June 30 as borrowings related to new purchases were partially offset by paydowns of non-recourse borrowings related to non-QM securitizations and as total equity increased. Our recourse debt to equity ratio adjusted for unsettled purchases and sales was unchanged at 1.9:1 as of September 30 as borrowings related to new purchases increased roughly in proportion to total equity. Finally, our weighted average borrowing rate was just slightly higher at 1.27% as of September 30 as compared to 1.24% at June 30.\n\nFor the third quarter, total G&A expenses declined by $0.01 to $0.16 per share, while other investment-related expenses were $0.06 per share as compared to $0.11 per share in the prior quarter, mainly due to non-QM securitization issuance costs that we incurred in the prior quarter, but not in the third quarter. Also during the quarter, we recorded an incentive fee of $5.3 million as we exceeded our net income hurdle for the trailing four-quarter period. And we recorded an income tax benefit of $2 million, primarily due to a decrease in current deferred tax liabilities related to the reduction in the unrealized gain on our investment in Longbridge Financial. Finally, our book value per common share was $18.35 per share at September 30, down slightly from $18.47 per share at June 30. Including the $0.45 per share of common dividends that we declared during the third quarter, our economic return for the quarter -- for the third quarter was positive 1.8%.\n\nNow, over to Mark.\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nThanks, JR. Q3 was interesting in that we saw a lot of interest rate volatility as the Treasury market seemed to grapple with the tension between the spread of the Delta variant and high inflation. In contrast, credit spreads were relatively calm. In the third quarter, we got a lot of clarity from the Fed about the pace of taper and we now have further specifics on the plan based on the timeline discussed in the last week's Fed meeting. Starting this month, the markets are entering a new phase of diminished Fed support. The Fed has gone out of its way to provide clarity about its plans, but that doesn't mean the taper is a non-event. Growth in the Fed's Agency MBS and Treasury portfolios has provided support for all financial markets by putting cash in the system. And during the taper period, which is expected to end next June, they will continue to put cash in the system, albeit at a slower pace. So we think that means, over the course of 2022, we may see somewhat wider credit spreads and yields.\n\nSo for EFC, those are welcome changes as wider spreads [Technical Issues] higher core earnings plus we have dry powder to deploy from our capital raise in October. Already in September and continuing into October, we have seen some spread widening. Spreads on investment-grade non-QM, CMBS and CLOs have all widened in an orderly fashion. We've talked on previous calls about how loans had not compressed as much as security yields in the past year. Well, that has partially reversed since quarter-end as spreads have widened so far into Q4. But this spread widening is not the result of any hiccups in credit performance, rather it's the result of a market demanding wider spreads because of an influx of new issue.\n\nThe other thing we are paying close attention to is supply and demand and affordability trends in the housing market. Since COVID, the housing market has been appreciating at an incredible pace. If mortgage rates drift higher without robust wage growth, affordability may become an issue. So for EFC, we can't get complacent about the strength of the housing market. We will be monitoring it quite closely.\n\nThis quarter end, we have also seen lower loan prices in some sectors, which inevitably happens when securitization economics are squeezed by wider spreads and higher yields. I like the balance we have at EFC, achieved by owning both originators and securitization machines. When loan prices are high, like this quarter, EFC benefits through robust gains on sale. As loan prices come off, and loan sale margins compress, that benefit accrues to the securitization business. We believe that by being more vertically integrated in the raw loan to security supply chain, EFC can thrive whether the economics favor the loan originator or the securitization sponsor.\n\nIn fact, we've already made three additional equity investments in originators so far this year. We plan to use the same playbook with these new investments that we used successfully for LendSure. We make small investments so we don't have a lot of capital at risk. We secure loan volume for EFC and we look for situations where EFC's financial strength and Ellington's data science and industry relationship can give our partners a competitive advantage over peers that lack those resources. We also give new partners the benefit of our experience in growing origination platforms.\n\nTurning to third quarter results, overall credit performance for our portfolio was very strong. Consumer balance sheets remain in good shape. HPA has surprised to the upside and a continued rebound in commercial real estate values and deal activity drove solid performance in our commercial loan portfolio. Core earnings covered the dividend and I think that's great, given our increased capital base.\n\nYou can see on Slide 6 that we had significant growth in our credit portfolio. The residential mortgage strategies grew most significantly this quarter, driven by non-QM and RTL. The commercial real estate portfolio actually shrunk sequentially, but that was due to opportunistic CMBS sales. Nonetheless, our small balance commercial mortgage holdings actually increased quarter-over-quarter and we continue to see a lot of attractive deals in that sector.\n\nYou can see on Slide 9 that we have 95% of our credit portfolio in our three primary sectors: residential mortgage, commercial mortgage, and consumer. We also had modest growth in our Agency MBS portfolio during the quarter. We are positioned to increase our net Agency mortgage exposure, should diminishing Fed support and year-end liquidity issues present us with opportunities.\n\nOn Slide 10, you can see that our small balance commercial mortgage loan portfolio, we are well diversified across many dimensions and are in a first lien positions on every loan with the vast majority being floating-rate loans that benefit from interest rate floors. We issued stock in Q3. It's great that our portfolio companies and other loan sourcing relationships have grown and matured to the point where it was relatively easy for us to deploy the additional capital. I've also been really happy to see the greater liquidity in our stock. Despite substantial portfolio growth this quarter, with our growing capital base, we have a lot of room to take advantage of market opportunities. Consistent Fed purchases have been a great source of stability in 2021 as the Fed has grown its Agency MBS portfolio by over $400 billion. As that support wanes, we think that private capital may be able to demand even more attractive yields.\n\nNow, back to Larry.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nThanks, Mark. I'm very pleased with Ellington Financial's performance so far in 2021 and particularly with the progress that we've made growing our origination businesses and loan portfolios. Following quarter end, we again accessed the capital markets to continue driving this growth. In October, we raised just over $100 million of common equity, again at around book value. We've already invested the majority of this new capital but in addition to fueling continued loan portfolio growth, the additional capital should provide us with additional economies of scale in our portfolio and the capital markets and operationally. This additional capital also positions us to be opportunistic, should we see any pockets of volatility around year-end, whether they be related to macro concerns around inflation or COVID, Fed tapering concerns or even just typical year-end balance sheet pressures.\n\nSo we're in a strong position to play offense as we move into the final weeks of the year. Meanwhile, we will continue to work on cultivating and expanding our proprietary loan pipelines, while also being opportunistic with our security strategies and staying disciplined on risk and liquidity management to protect and preserve book value.\n\nFinally, I'd like to point out that with our latest capital raise, Ellington Financial has now passed the $1 billion mark in total common equity market capitalization. That's a significant milestone for EFC and it's one that we believe will further increase our visibility in the market, increase the liquidity of our stock for our stockholders and enable us to access both the debt and equity capital markets more efficiently. In fact, if you look at our capital structure, you can see that at this point, we're especially well-positioned to add debt or preferred equity to our balance sheet. In particular, our $86 million of senior unsecured notes will become freely refinanceable on March 1. And with the additional equity on our balance sheet following our recent stock issuances, that could be a good time to both lower the cost of, and increase the size of our outstanding unsecured debt, thereby leveraging up our balance sheet and helping drive core earnings higher still.\n\nWith that, we'll now open the call to questions. Operator?\n\nOperator\n\n[Operator Instructions] And we will take our first question from Doug Harter with Credit Suisse.\n\nDouglas Harter -- Credit Suisse -- Analyst\n\nThanks. Hoping you could talk a little bit more about the three investments you made in originators. What type of products do they make? And I guess how would you think about that adding to the pipeline of loan opportunities?\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nYeah, we're not going to provide any additional color on that other than to say that they are all in the residential area. We are working on at least one of the commercial area as well now, but those are just all in the residential area and they are, as we said, they're small investments and it's probably going to be a little while before you see very meaningful growth to portfolios, but in markets like non-QM and a little bit of everything in the residential space.\n\nDouglas Harter -- Credit Suisse -- Analyst\n\nOkay. And then you mentioned some of the spread widening in securitizations, can you just -- given that, can you just talk about kind of where you see returns and how the execution of the securitization, where that moves returns today?\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nSure, it's Mark. So you saw just a tremendous amount of supply in a lot of sectors in October. You had a lot of mortgage 2.0 supply, some of that non-QM, some of that Agency-eligible investor deals, you saw a lot of CLO supply, you saw a lot of CMBS supply. And so you've seen a little bit of widening investment-grade bonds and now I think that's being matched by slightly lower loan prices. So when I net the two together, I don't see a big difference in securitization economics, other than that, it means with lower loan prices, we are retaining less pre-payment risk which I think is generally a good thing.\n\nDouglas Harter -- Credit Suisse -- Analyst\n\nGreat, thank you.\n\nOperator\n\nWe'll go next to Crispin Love with Piper Sandler.\n\nCrispin Love -- Piper Sandler -- Analyst\n\nThanks. Thanks, good morning and thank you for taking my questions. First, looking at Slide 9 with the credit portfolio breakout, I can't recall a time where the residential portfolio was near the 64% level that you are now. So, is that largely due to the opportunities you're seeing in non-QM and RTL and the flow you're getting? Or are you at all incrementally more negative on the commercial mortgage market? And also in the presentation, it looks like you might have increased your CMBS hedging a little bit. So just a little color there would be great.\n\nJR Herlihy -- Chief Financial Officer\n\nSure. Hey, Crispin, it's JR. Yeah, I think the first thing you suggested is spot on, namely, it's driven by larger non-QM portfolio quarter-over-quarter. I mean, just to put some numbers on it, at September 30, our non-QM portfolio was about $585 million of the around $1.7 billion of the credit portfolio, so about 35% whereas at June 30, those numbers were about $300 million and 22%. So, by far, the biggest driver there is non-QM, followed by Residential Transition Loans. Larry mentioned that those two strategies were record quarters for Ellington Financial in terms of origination volume. So that's directly reflected on this pie chart. I would say that the point about commercial mortgages, we are definitely -- and Larry mentioned it as well in his prepared remarks, we're definitely seeing growth there. The slide also has CMBS where we had opportunistic sales. So you have some offsetting sales and pay-downs offsetting growth in the small balance commercial mortgage sector. So I would say we are very excited about the loans we're seeing in commercial real estate. We would expect to see continued portfolio growth there as well.\n\nCrispin Love -- Piper Sandler -- Analyst\n\nOkay. Thanks, JR. And then did you also mention that LendSure is looking at adding some additional products in addition to non-QM? And is there any color that you could give there or would you expect to get flow from the new products as well, should they happen?\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nSure, it's Mark. So I think there is a lot LendSure can do. The senior management team is extremely experienced and extremely thoughtful about mortgage credit. So there could come a time where they start getting involved in the RTL space. They have been having a lot of internal discussions and they're starting to lay the groundwork to potentially get involved in the prime jumbo space. So I would say those two sectors, I think now, are the ones that are closest to actually them starting to originate loans. We've liked non-QM. It's played well to us, because you don't have much of a bank presence there. There is an IO component to it that you have to value. So just a lot of things that sort of we have core expertise at, have sort of meshed nicely with non-QM. So that's why that's been the initial focus.\n\nCrispin Love -- Piper Sandler -- Analyst\n\nOkay and then just one quick clarifying question on the originator stakes. Is there -- did you disclose one more than you did last quarter because I think last quarter you said that you added two and then I saw the commentary, OK, you've added, I believe it's three in the last six months. So is there one additional one or all three are new?\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nNo, you're right, it's one additional one during the third quarter. And so it's three in total the last six months, so one incremental in Q3, and then we have several others that are, I would say, in discussion that we're hoping to close by year end.\n\nCrispin Love -- Piper Sandler -- Analyst\n\nGreat, thank you.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nThank you.\n\nOperator\n\nWe'll go next to Brock Vandervliet with UBS.\n\nBrock Vandervliet -- UBS -- Analyst\n\nHey, good morning. Could you just talk generally about competitive dynamics in resi transition and non-QM as well? Are you seeing other much larger organizations take another look at those sectors, look to move in and broaden the market? And if and when that happens, is that any sort of -- do you look at that as any sort of a competitive threat to your program or kind of a rising tide where it just boosts the profile of these loan niches?\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nHey, Brock, it's Mark. So I would say in the RTL space, that has -- there has been more of a focus there. It's gotten sort of more publicity in the past year than what it has had in the past. So in that space, I do think there are some larger pools of capital focused on that space, but it's a very fragmented space and the way we do it is really dependent upon thoughtful underwriting of the projects and really understanding the local housing market. So I don't see it as a threat. Larry mentioned in his prepared comments that we think that can be a lot of growth for us over the long run. The median age of homes in this country is very old. There is a lot of deferred maintenance that needs to get done. So I think we have ample opportunities to grow our volumes there. But I do -- just from what I read, I do think there has been a little bit more focus on that sector from some large pools of capital than what you might have seen, say, pre-COVID, say, 2019.\n\nBrock Vandervliet -- UBS -- Analyst\n\nGot it. Okay. And just rotating over to Longbridge and the MSR, looking at the yield curve now, it seems like the pain trade may be on here in terms of lower rates and a flattening. Any changes contemplated in terms of their hedging methodology, those sorts of thing?\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nNo -- hey, it's Larry, no expected changes in terms of hedging methodology. It's just a little different from the forward MSR market where it's so tied just to the absolute level of mortgage rates in comparison to the outstanding stock of mortgages. Here, yes, rates have sort of been low, but it wasn't low rates alone that was the trigger. It was also combined with just continued home price appreciation and then you've got a bunch of borrowers who can take advantage of that by borrowing more against their homes, basically, it's a cash-out situation where they can replace their old loan with just a bigger loan. So it's not -- so that aspect really isn't all that hedgeable and the other aspect that's also not that hedgeable is that there is really no TBA market where you could sell HMBS forward. And so -- but I think the good news is that we do believe that this is behind us. HMBS prices are about as low as they've been in a while or they were about as low as they were in a while when this write-down took place. And so I think that -- I certainly think that when you look at the fact that originations continue to be incredibly strong and their market share continues to grow, we just feel great about company's prospects.\n\nBrock Vandervliet -- UBS -- Analyst\n\nOkay. Thanks for taking my questions.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nThank you.\n\nOperator\n\nWe'll go next to Bose George of KBW.\n\nBose George -- Keefe, Bruyette and Woods -- Analyst\n\nHey, guys, good morning. So just maybe one more on Longbridge. Just in terms of the -- I guess, the positive side of the home price appreciation, etc., can you just talk about gain on sale trends in the reverse business, sort of, how are some of those fundamentals trending?\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nYeah, sure. The -- Longbridge itself, really we don't believe there's that much exposure sort of from a credit perspective, right, because these are FHA-guaranteed mortgages ultimately that they are originating. So, yeah, so in terms of gain on sale, right, the biggest headwind there, right, was just that they had loans in the pipeline, right, that we're committed to, and in some cases already closed on. It takes a little while to sell those in the form of HMBS and so the gain on sale was just a lot lower and in some cases, on some loans, negative after the HMBS market had that spread widening event. So again, that was sort of once that -- loans that were either already closed or in the pipeline, once those are flushed out of the system, now we've seen profit margins come back and there is elasticity in the market, because where they are originating loans, buying loans, there is -- especially in the wholesale market, there is definitely elasticity there.\n\nSo they've been able to cut their prices that they're buying loans out in the wholesale market and therefore restore most of the gain on sale profitability per unit that they had previously. So again, October was nicely profitable, again, very profitable and we think that origination volumes should continue to be very strong. It's a -- as you probably know, it's a market that there's just not that many players in, and Longbridge is one of the most significant, obviously, as we said, Number 3 HMBS issuer. So yeah, we really feel good about the gain on sale prospects going forward.\n\nBose George -- Keefe, Bruyette and Woods -- Analyst\n\nOkay. And then the spread widening that you saw there, I mean was that caused by the pickup in pre-payments or was that the main driver?\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nYes.\n\nBose George -- Keefe, Bruyette and Woods -- Analyst\n\nOkay, great, thanks. And then next, just switching over to the capital in operating companies. Can you just talk about the incremental allocation? Is there kind of a level of allocation that you'd -- where we could think this could go as you obviously are continuing to sort of invest in new operating companies?\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nYeah, I don't think -- we're going to continue to take the opportunities as they present themselves and as we find them. We have been definitely proactively looking at -- we sometimes -- it will be, for example, an originator that we're buying loans from and then we'll -- after seeing the quality of their business, we'll then approach them and see if they're interested in selling us a stake and obviously, as we said, we give them lots of things in return. Sometimes we give them additional credit lines, the data and analytics that Mark mentioned before. So we don't really have a budget in terms of how big we want this portfolio to grow. We're certainly able to have substantial growth and still meet the retest as you probably know that the TRS test is measured on a gross asset basis. So we have plenty of growth there.\n\nWe've -- as Mark said, we focused more on smaller investments initially. I mean, just, example, LendSure, our original investment was under $5 million, right, and now that's obviously worth a lot more. So we would rather make these investments and not have as much capital at risk just based upon overall cyclical changes in the origination business. We'd rather have less at stake there. And obviously, if we can symbiotically increase their origination and our flows, that just works for everyone. And that's an important -- obviously been a very important component as you can see with LendSure in terms of what -- the way we've been able to grow our loan portfolios.\n\nBose George -- Keefe, Bruyette and Woods -- Analyst\n\nOkay, great, thanks.\n\nOperator\n\nWe'll go next to Trevor Cranston with JMP Securities.\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nHey, thanks. Question on the couple of the recent changes we've seen from the FHFA, specifically in terms of bringing back CRT issuance and removing the caps on the GSE investor loan purchases. But just curious if you guys have any thoughts on how bringing back CRT and potentially reducing some of the private label issuance of the industrial loans impacts the overall supply demand dynamics of the resi credit sector?\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nIt's a great question, Trevor. So, it's Mark. So I would say, for the caps on the investor loans, I don't think that's going to have a big impact on private label issuance in that sector because private label issuance in that sector right now is being driven by -- it's just economically better for -- it's just better economically to issue in the private label market if people are willing to -- if you have private capital willing to underwrite the credit risk levels better than what the GSEs have done, and if you have private capital willing to take some of the aggregation risks. So I think you could continue to see private capital involved in the Agency-eligible sector.\n\nIn regards to CRT, I guess we sort of view that pause as what was the aberration and not so much the restarting of it. I think CRTs has been an important way for the GSEs to mitigate shareholder risk on the guarantee fee business. So we think that will continue. The one thing I would say that you have these changes now in leadership at FHFA, so we wouldn't be surprised at all to see additional changes. And there is a lot that can be done with the GSEs to promote some of the goals of more affordable housing, more first-time homeowners, and there has obviously been challenges to that from some business lines that are out there now. There have been some people that have been critical about the single-family rental business, that it squeeze that first-time homebuyers. And so I think you're going to see dynamic policy changes going forward.\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nOkay, that's helpful color. Thank you, guys.\n\nOperator\n\nWe'll go next to Eric Hagen with BTIG.\n\nEric Hagen -- BTIG -- Analyst\n\nHey, thanks, good morning. Maybe just one. How sensitive do you guys expect the cost of repo in the credit segment might be to changes at the short end of the yield curve, including the haircut that gets applied on that collateral? And can you remind us the collateral which is pledged there right now? Thanks.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nI can take [Speech Overlap] go ahead, Mark. Go ahead.\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nOkay. So I would say, we don't anticipate significant changes in haircuts, and that's because you've had stable credit performance and you've had relatively stable asset prices. Increases in haircuts are normally a consequence of either weakness in performance and/or weakness in asset prices. Yeah, we think that the changes in repo costs, we think they're going to track what the Fed is going to do on the short end. One thing we've done on the Agency side of the portfolio where you have a little bit more dynamic financing market is we have extended the term of our repo because we thought it was advantageous. So we've done some one-year repo. And we think that the one-year repo rates are certainly going to go up because now that's sort of spilling into -- close to a period of time where people think the Fed could be active. So in terms of net interest margin, if you have assets priced off the front end of the curve like a lot of the non-QM loans or floating-rate assets like a lot of the commercial bridge loans, I think our net interest margins are going to hold up very well because we don't expect a change in repo spread to a change in haircut, but I do think, just the overall levels of LIBOR are going to affect our financing costs.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nAnd I just -- just to add to what Mark said, so I think if you look at Agency repo, the haircuts there, historically, I mean they have been incredibly steady and resilient, really since the financial crisis, I would say, the 2008 financial crisis. So right around -- for customers like us, right around in that 5% to 6% area. And frankly, that's plenty of leverage, being able to lever 16, 20 times, 5% or 6% haircut is plenty of leverage. So we certainly don't see, let's say, if rates go up or something like that because of the taper or the end of easing or whatever you want to call it, it's -- I don't think you're going to see a significant increase in Agency haircuts at all. And in terms of spreads, those really have tracked -- again, other than in certain extreme situations like COVID, those really have tracked very closely just the general collateral, treasury, SOFR market now, you call it. So obviously a few basis points here or there, it can move, but if you look at, and certainly in recent times, and I think we -- in our Ellington Residential deck, we actually have a slide on that in terms of just repo costs and things like that. But it's a very close tracking.\n\nNow, I think where it gets interesting is in the credit sector, right, because we also -- we have repo not just in Agency mortgages, we also have them in non-Agency RMBS and in all the other products that we invest, including loans, right? Some of our loans are actually financed via repo. And there, when you look at the haircuts and spreads, you've seen nothing but compression. And I think the pattern there is that you'll have an event in the market like COVID in early 2020 and then in response to that, right, that's a liquidity crisis, you're going to see haircuts go up immediately, you're going to see yield spreads go up on the assets themselves and you're also going to see financing spreads go up. So that happened and then the asset always seems to lead the financing historically. I think that's been the pattern, really both ways. So you'll -- since then, obviously in the last year and a half, you've seen haircuts steadily come down, you've seen spreads steadily come down. They haven't come down as fast as the asset yields have come down, but I think the trend is still in that direction. So we're certainly hopeful that we'll continue to see and I believe you will continue to see spreads on the credit assets and their repo continue to compress and haircuts maybe compress a little bit from here.\n\nEric Hagen -- BTIG -- Analyst\n\nThanks a lot. Appreciate it.\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nThank you.\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nThank you, Eric.\n\nOperator\n\n[Operator Closing Remarks]\n\nDuration: 48 minutes\n\nJason Frank -- Deputy General Counsel and Secretary\n\nLaurence Penn -- Chief Executive Officer & President, Director\n\nJR Herlihy -- Chief Financial Officer\n\nMark Tecotzky -- Co-Chief Investment Officer\n\nDouglas Harter -- Credit Suisse -- Analyst\n\nCrispin Love -- Piper Sandler -- Analyst\n\nBrock Vandervliet -- UBS -- Analyst\n\nBose George -- Keefe, Bruyette and Woods -- Analyst\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nEric Hagen -- BTIG -- Analyst\n\nMore EFC analysis\n\nAll earnings call transcripts\n\n"}
{"id": "002fd059-fd86-4fb7-a459-139531d2ab4f", "companyName": "Academy Sports And Outdoors", "companyTicker": "ASO", "quarter": 3, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/12/07/academy-sports-and-outdoors-aso-q3-2022-earnings-c/", "content": "Academy Sports And Outdoors\u00a0(ASO -0.58%)\nQ3\u00a02022 Earnings Call\nDec 07, 2022, 10:00 a.m. ET\n\nOperator\n\nGood morning, ladies and gentlemen, and welcome to the Academy Sports and Outdoors third quarter fiscal 2022 results conference call. [Operator instructions] I will now turn the call over to Matt Hodges, vice president of investor relations for Academy Sports and Outdoors. Matt, please go ahead.\n\nMatt Hodges -- Vice President, Investor Relations\n\nGood morning, everyone, and thank you for joining the Academy Sports and Outdoors third quarter 2022 financial results call. Participating on the call are Ken Hicks, chairman, president, and CEO; Michael Mullican, executive vice president and CFO; and Steve Lawrence, executive vice president and chief merchandising officer. As a reminder, statements in today's earnings release and the comments made by management during this call may be considered forward-looking statements. These statements are subject to risks and uncertainties that could cause our actual results to differ materially from our expectations and projections.\n\nThese risks and uncertainties include, but are not limited to, the factors identified in the earnings release and in our SEC filings. The company undertakes no obligation to revise any forward-looking statements. Today's remarks also refer to certain non-GAAP financial measures. Reconciliations to the most comparable GAAP measures are included in today's earnings release which is available at investors.academy.com.\n\nUnless otherwise noted, comparisons are to 2021, but 2019 comparisons also provided where appropriate to benchmark performance, given the impact of the pandemic in 2020 and 2021. I will now turn the call over to our CEO, Ken Hicks.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThank you, Matt. Good morning, and thank you, all, for joining us today. As we anniversary our second year as a public company, I'm proud of the operational and organizational initiatives we've undertaken that have transformed the company and helped drive our solid financial performance. Our talented team of retail leaders have improved every aspect of our company when compared to pre-IPO Academy, including improving our merchandise planning and allocation processes; building an outstanding assortment of good, better, best products for our customers while maintaining our focus on value; significantly enhancing our e-commerce capabilities; increasing customer loyalty through the launch of the Academy credit card; modernizing our marketing, along with our store experience; and meaningfully improving our financial stability.\n\nWe are in excellent financial health capable of self-funding all of our capital priorities, which include new store expansion, omnichannel growth, technology enhancements, increasing supply chain capacity, and rewarding shareholders through share repurchase and dividends. The third quarter was challenging, and our reported net sales of 1.49 billion, a negative 7.2% comparable sales, were below our expectations. We saw sales increases in footwear and apparel but experienced sales decline in outdoors and sports and recreation. Steve will discuss our sales results in more detail later in the call.\n\nWhen comparing third quarter sales to 2019, we maintained a 30% growth trend, which is in line with what we have seen year to date. We believe this is a strong indicator that our business is baselined at a much higher level post-pandemic, and there is ongoing durable consumer demand for the sports and outdoors category. Looking at our third quarter profitability, adjusted earnings per share were $1.69, which is below last year, but in line with our expectations. We maintained a 35% gross margin rate with an improved mix of products, increasing merchandise margin rates, and controlling cost.\n\nWe also held a double-digit EBIT margin and, for the second year in a row, expect to end the fiscal year with an annualized EBIT margin rate above 10%, which is one of our long-term financial goals. The freshness and in-stock position of our inventory across most of our categories is in very good shape. We believe we have the right amount of product from key partners like Nike, adidas, and Under Armour to offer customers what they are looking for this holiday. There will likely be more promotional activity in the marketplace this holiday season, but we are prepared to be competitive with our own planned promotions, as well as our everyday value positioning, which is in our plans.\n\nWhile we know that our customers have been under inflationary pressure and do not have the stimulus money they had last year, they are still focused on health and wellness, pursuing their hobbies, and winning their kids to participate in their sports and activities. Our good, better, best assortment of top national brands and strong private brands available at everyday value prices allows them to continue to do that at an affordable price. As a reminder, the majority of our customers are in the middle three quintiles ranging from $50,000 to $150,000 in annual household income. There's also an ongoing population migration to our base in the South and Southeastern United States.\n\nWe currently operate in some of the fastest growing markets in the country, such as Austin, Texas; Atlanta, Georgia; and Raleigh, North Carolina. We are uniquely positioned to benefit from this shift and intend to capitalize on it by executing our growth plan of opening 80 to 100 new stores between 2022 and the end of 2026. During Q3, we opened four stores in Richmond, Virginia; Atlanta, Georgia; Lexington, Kentucky; and Jeffersonville, Indiana. We have also opened three stores in Q4: one here in Houston; one in Tampa Bay, Florida; and one in a new state for us, Barboursville, West Virginia.\n\nThese store openings were a mix of locations in existing, adjacent, and new markets. We are measuring and analyzing the different market types and all aspects of the opening process, marketing, merchandising, localization, seasonality, and staffing, to gain a better understanding of our approach and optimize our process as we open even more stores in 2023 and beyond. I want to give a big thanks to all of the team members who helped execute through successful store openings. The Academy team remains focused on executing our priorities to achieve our vision to become the best sports and outdoors retailer in the country, while providing fun for all through assortment, value and by delivering a great experience for our customers and creating value for our stakeholders.\n\nI will now turn the call over to Michael to provide more detail on our third quarter financial results, new stores, and provide an update on our 2022 guidance. Michael?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nThanks, Ken. Good morning, everyone. Academy delivered another profitable quarter for shareholders despite ongoing macroeconomic headwinds by prudently managing inventory, expanding merchandise margins, and controlling expenses. Since going public more than two years ago, we have consistently demonstrated that we have achieved a material step-up of our earnings potential and free cash flow generation compared to years past.\n\nIn the third quarter, net sales were 1.49 billion, with comparable sales down 7.2% as we anniversaried a strong Q3 2021 comp of 17.9%. The sales decline was a result of lighter traffic and fewer transactions compared to last year. But overall, we have maintained the market share gained over the last two years in each of our merchandise divisions. We saw share gains this quarter in apparel and footwear, resulting in our sales mix team being more balanced between hard and soft goods compared to recent quarters.\n\nOur e-commerce sales increased 10.5%, marking the fifth consecutive quarter of double-digit growth and represented 9.5% of merchandise sales. When compared to Q3 2019, our e-commerce business has grown 173%, and the penetration rate has more than doubled. As we have stated before, we believe academy.com is a competitive differentiator for us in a very meaningful part of our future growth that we intend to invest in for the foreseeable future. As Ken said, we have completed all nine of our planned store openings for 2022.\n\nAcademy stores have the highest store productivity in our peer group, making our new stores an effective use of our capital with a high return on investment. During Q3, our existing store productivity was once again best in class. Trailing 12-month sales per square foot were $351 per foot and trailing 12-month operating income per store was $3.2 million. Gross margin dollars during the quarter were $522.5 million with a rate of 35%, only 20 basis points below last year's record third quarter of 35.2%.\n\nAs Steve will tell you more about in a minute, we increased our merchandise margins compared to last year despite various external pressures as our refined merchandise planning and allocation processes continue to generate margin opportunities. We also saw a shift in our sales mix toward soft goods. These margin gains were partially offset by an increase in e-commerce shipping costs and shrink during the quarter. Since the pandemic, we have over-indexed on the hard goods side of the business.\n\nAnd as our mix shifts back to soft goods, our gross margin rate should benefit. SG&A expenses were 23% of sales, a 140 basis-point increase compared to last year. The change was primarily a result of fixed cost deleverage from the decline in sales and additional pre-opening expenses associated with opening new stores. Operating income for the quarter was 179.5 million or 12% of sales.\n\nAcademy has now delivered double-digit operating margins for seven straight quarters. Through the first three quarters of this year, we have generated over 640 million of operating income, which is more than the company earned in all of fiscal 2019 and 2020 combined. This is a clear indicator that the operational and organizational improvements made over the past few years have structurally changed and enhanced the earnings power of Academy. Third quarter GAAP diluted earnings per share were $1.62 per share compared to $1.72 per share last year.\n\nAdjusted diluted earnings per share were $1.69 per share compared to $1.75 per share last year. Looking at the balance sheet. Academy ended the quarter with 318 million in cash and had no outstanding borrowings on our $1 billion credit facility. Our positive cash flow generation remained strong as we delivered $50.8 million in net cash from operating activities.\n\nDuring the third quarter, we executed on our capital allocation plan, in part by investing in the following: opening 4 new stores, repurchasing 2.2 million shares for approximately $100 million, paying out $6 million in dividends, investing in supply chain and technology enhancements; and lastly, maintaining a healthy cash balance. In addition, the board recently declared a dividend of $0.075 per share payable on January 13, 2023, to stockholders of record as of December 20, 2022. Looking at our inventory, our ending inventory balance was 1.5 billion, a 12.8% increase compared to Q3 2021. When compared to Q3 of 2019, inventory dollars were up 12.3%, while units declined by 10% on the 30% sales increase.\n\nThis demonstrates that we have effectively managed our inventory while experiencing significant sales growth. To illustrate, when comparing revenue versus inventory per square foot this quarter to Q3 2019, revenue per square foot has increased 28%, while inventory per square foot has only increased 10%. Lastly, based on our year-to-date results and current trends, we are narrowing our sales and earnings guidance and raising our full year 2022 earnings per share forecast as follows: comparable sales are expected to range from down 6% to down 5%; GAAP income before taxes is expected to range from $790 million to $810 million with an expected gross margin rate of 34% to 34.5%; GAAP net income of between $610 million and $620 million; GAAP diluted earnings per share of $7.25 per share to $7.40 per share. Adjusted diluted earnings per share, which excludes certain estimated expenses, such as stock compensation and store pre-opening expenses, are now expected to range from $7.50 per share to $7.65 per share.\n\nThe earnings per share estimates are calculated on an updated share count of 84 million diluted weighted average shares outstanding for the full year and do not include any potential repurchase activity using our remaining $400 million authorization. We remain confident that our business model, driven by our transformed retail capabilities and the everyday value of our products, positions us well to navigate this uncertain environment and to win this holiday season, but also to drive long-term sales and profits. With that, I will now turn the call over to Steve, who will give you more details around our merchandising and operations performance. Steve?\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nThanks, Michael. As you heard earlier, our Q3 sales came in at $1.49 billion, which was a 7.2% comp decline versus 2021, but up 30% versus our 2019 baseline. This is a little lower than the first two quarters, which were up 36% versus '19, but we're pleased that we continue to hold on to the large majority of the gains from the past couple of years despite a more challenging macroeconomic environment. It was also good to see three of our four divisions showing an improvement in the trend versus last year during third quarter.\n\nFootwear was our best performing division in the quarter, with sales coming in at a 5.1% versus last year, and up 32% versus '19. We got off to a strong start during back-to-school and footwear and saw the momentum carried throughout the quarter. As you'd expect, a lot of the categories that spike during back-to-school, such as kids shoes and cleats, were some of the leading performers during the quarter. We also continue to see strong sales in key brands, such as Brooks, Crocs, and SKECHERS, along with a very successful launch of HEYDUDE across all of our stores.\n\nApparel sales also rebounded in Q3 with an increase of up 0.5% versus last year, which was a dramatic improvement versus our spring trend. Like footwear, we continue to run double-digit comps for 2019 baseline of up 24%. Back-to-school results were also strong in apparel, and the momentum that started early on carried forward into the remainder of the quarter. This momentum, coupled with an improved inventory position and top brands, such as Nike, Columbia, and Carhartt, versus last year helped spark selling in fall seasonal categories, such as fleece and outerwear.\n\nWhile our sports and direct business in Q3 was down 4% to last year, it was also an improvement versus our spring trend and was up 40% versus 2019. We continue to see solid gains in our sporting goods business with the strength across key categories such as football, baseball, and golf. The softest category in this area remains the home fitness business, which declined double digits versus last year but has stabilized at up over 25% versus our 2019 baseline. Our biggest challenge during Q3 was our outdoor business, which posted an 18.3% decline and was the only category where Q3 sales softened versus the first-half trend.\n\nIt's also important to note that we continue to hold on the majority of the gains we picked up over the past couple of years in outdoor with this business still running up 30% versus 2019. Softest category was hunting, where we struggled to anniversary high double-digit comps in ammunition from last year. We're up against the sales spike driven by large receipts that were helping us get back in stock during Q3 of 2021. Broadly speaking, the overall inventory level from ammunition have stabilized across the industry over the past year.\n\nWe started to see a lot of the stock-up surge activity by consumers drop off, which has resulted in slowing demand. While running negative comps versus last year, the ammunition business continues to run up triple digits year to date versus 2019, and we saw the declines versus 2021 start to lessen as we got deeper into the quarter. To sum it up, the miss in outdoor, largely driven by ammunition, comprised over 100% of our drop for the company, so stabilizing this business is a clear priority for us. Shifting to margins.\n\nAs planned, we held on to most of the gains we've made over the past couple of years. Gross margin rate for Q3 came in at 35%, which is a 20 basis-point decline versus '21, was up 340 basis points versus 2019. Similar to the last couple of quarters, beneath the surface, our merchandise margin was up 60 basis points versus last year and continues to run well ahead of 2019 levels. We attribute the continued strength in gross margin to a combination of the hard work the teams have done over the past couple of years around improved buying and planning and allocation disciplines, coupled with a favorable mix of sales in the higher-margin categories of apparel and footwear.\n\nAs we finish out the year, we built in a well-thought-out promotional calendar for this Q4. This cadence is more aggressive than the past two holiday seasons and is focused on driving traffic to our stores by providing our customers with outstanding deals on giftable items. These additional promotions are accounted for in the guidance Michael discussed earlier. And our expectation is that despite this uptick in discounting, we will continue to hold on to most of the margin gains from the past couple of years.\n\nWe also believe that our everyday value pricing, coupled with our thoughtful promotional strategy, will allow us to maintain our position as a value leader in our space and gain market share during Q4. In terms of inventory, our teams continue to do an outstanding job in managing through a challenging environment. We ended the third quarter with inventory up 13% versus last year, which is lower than the 17% increase we entered the quarter with. Our inventory levels and content are in the best position they've been in over the past couple of fourth quarters, putting us in a prime position to take advantage of the holiday traffic surge.\n\nAnother sales driver for us is continuing to lean into new initiatives and brands that resonate with our core target customers. Couple of funding ideas that we put in place for this holiday, including launching Christmas-themed Magellan Outdoors apparel, expanding into gas-powered ride-ons from Coleman, along with adding Ukiah and BioLite FirePit into our outdoor heating. All of these ideas should help reinforce Academy as the best destination for all things sports and outdoors. The team has worked hard to get back in stock and ensure that our inventory is much better balanced to the position, and the key brands and categories will drive customers into our stores for this holiday.\n\nOur everyday value pricing, coupled with a strong well-thought-out promotional cadence, will allow us to deliver a strong value proposition this holiday. When you combine that with our broad assortment of the most desirable brands and our strong in-store experience, we believe that we have a winning formula to continue to pick up market share. Finally, we also continue to lean into more digitally targeted advertising, while reducing our reliance on traditional broadcast and print. This shift helps improve our overall marketing reach and effectiveness while also allowing us to be much more nimble in reacting to pricing promotions.\n\nIn closing, we believe that we have the proper strategies in place and are well positioned to drive the business and continue to gain market share during the very important Q4 time frame and beyond. Now, I'd like to turn the call back over to Ken for some closing comments. Ken?\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThank you, Steve. Despite the challenging macro environment, we've delivered a solid operational and financial performance this year. We've made significant improvements over the past several years, resulting in our profitability being materially higher than just a few years ago. This is the result of our dedicated team working diligently toward our vision of becoming the best sports and outdoors retailer in the country.\n\nAcademy is well positioned to have a successful holiday season. This past Black Friday was the largest sales day in the history of the company, and we are maintaining the 30%-plus sales trend compared to 2019. That being said, we still have the biggest three weeks of the year ahead of us, but we are confident in our plan. Academy has enormous future potential growth opportunities from opening new stores, expanding omnichannel, improving existing stores, and from operational improvements.\n\nThere's a lot to be excited about, and we are prepared to execute to achieve our near- and long-term goals. I'd like to close by thanking all of the Academy sports and outdoors team members and wishing everyone a joyful holiday season. We'll now open up the call for your questions. Thank you.\n\nOperator\n\n[Operator instructions] Our first question comes from the line of John Heinbockel with Guggenheim. Please proceed with your question.\n\nJohn Heinbockel -- Guggenheim Securities -- Analyst\n\nHey, guys. I wanted to start with as you think about the fourth quarter, right, the implied comp right at the midpoint is down two. That's the sort of same trend line. So, not a multiyear improvement.\n\nBut how -- when you think about the four categories or the four divisions and you think about the prospect for improvement, right, sequentially in each of those four, where do you see the biggest opportunities, right, based on the merchandise content and the behavior of your customer?\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nHi, John. Thanks for the question. We obviously have seen good strength in our soft lines, apparel, and footwear categories, and they continue to provide an opportunity, as well as team sports, which has been a very good business with us. So, those are three of the businesses that I think we have, you know, good opportunities with.\n\nThat said, there's still challenges out there in some of the outdoor areas. But I'll let Steve provide a little more color.\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nYeah. If you go back to a year ago, the supply chain was still pretty much in disarray. When you look at where we're sitting today in terms of our ownership and seasonal categories, cold weather goods, giftable items for Christmas, we're in a way better shape than we were a year ago. So, we feel pretty confident about our inventory composition there.\n\nWe feel like our inventory is under control and that it's well balanced across all the areas. The one category called out as being challenging for us was the outdoor category. And beneath that, it's ammo is really the biggest challenge there. The good news is, you know, we're starting to see the trend line versus [Inaudible] get a little better.\n\nIt's still negative, but it's less negative than it was early in the quarter, and we're starting to see that business stabilize. So, you know, that's going to probably be a challenge for us throughout the remainder of this year. But we do feel like we're seeing strength in the other categories, which is helping offset some of that.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nAnd, John, a couple of more points in addition to the categories. We expect to have a good finish to December. The guidance that we provided implies that we're going to be up 30% to 2019, which is consistent with recent trends. That's in line with our quarterly and monthly builds, which are usually a pretty reliable indicator of our performance.\n\nIn addition to being better in stock and key holiday programs, as Steve mentioned, we're looking at the consumer and how they are behaving. We have some planned traffic dropping promotions, and we were not in a position to do that last year because we didn't have the inventory. And if you recall, last year, there was a scarcity of goods in the market, which led to a lot of early purchasing. This year, there's an abundance of goods.\n\nAnd so, we think that, coupled with a favorable calendar, there's an extra Saturday this year before Christmas, we'll probably see some late shopping. The weather hasn't been terribly helpful to sales. It's been a pretty warm start to the holiday season. So, we think the last couple of weeks, we'll see a lot of sales coming late.\n\nAnd as a reminder, we've invested a lot in our buy online, pick up in-store business. Our customers are leaning into that. And we're going to be in a good spot to deliver for them down the stretch.\n\nJohn Heinbockel -- Guggenheim Securities -- Analyst\n\nAnd then, maybe as a follow-up, right, on supply chain, you've had this distribution initiative for a little bit. Where do we sit on that? And when you think about capacity, I know you've got capacity for the time being. But as you look out capacity in the three DCs, and then, at some point, I guess you'll need a fourth DC, I guess, further north, how do you think about the network over the next three or four years?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nYou're correct. At some point, we need a fourth DC, and then we'll need a fifth. And as we grow to reach the potential of the company, we'll probably need a sixth at some point. For the next several years, we're in good shape.\n\nWe've got plenty of capacity. It is -- we think about the next five years of the business, we will start to incur costs and, frankly, think about adding a fourth distribution facility. We'll be in a position to speak more about that later. But for the next several years, probably until 2025, 2026, we're in a good position.\n\nJohn Heinbockel -- Guggenheim Securities -- Analyst\n\nOK. Thank you.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThanks, John.\n\nOperator\n\nOur next question comes from the line of Daniel Imbro with Stephens. Please proceed with your question.\n\nDan Imbro -- Stephens Inc. -- Analyst\n\nYup. Hey. Thanks for taking the question, guys. Good morning.\n\nCongrats. I want to start on the top line, maybe following up on the last line of questioning. So, you kind of implied, you know, continuation of 30% growth versus pre-COVID in the fourth quarter. I know it's early to think about 2023, but I guess maybe could you qualitatively talk about how you're thinking about next year? I mean, if you execute on your merchandising initiatives that, Steve, you laid out with the new brand, I mean, can you grow on this new base? Have we rebased to a point where growth is possible as we look out to next year?\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nI think one of the things that we're pretty confident is that we have rebaselined at a higher level. You know, if you go back each quarter this year, it's been in that low to mid-30s in terms of the performance versus 2019. So, we do feel like we're going to be building off a higher base. But that being said, it's still too early for us, I think, to give guidance for 2023 at this point in time.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nYes. As Steve said, not prepared to provide guidance for 2023 at this time. I will say, look, we have a few categories that, in this quarter, comprised 100% of the drop. And they're namely hunting categories, outdoor categories.\n\nThose categories are considerably stronger to 2019. And frankly, we expect most -- to maintain most of that gain in 2019 this year and beyond. We've got some categories that were really strong during COVID, and, you know, people call them COVID categories, COVID winners. Many of those actually haven't reverted to 2019.\n\nA great example is the outdoor cooking and outdoor furniture, which, collectively, in the quarter, were higher than they were last year. The rest of the business and the business as a whole is exceptionally healthy. We took share in soft goods this quarter, you know, despite being up against a lot of clearance in the market. Our inventory position is very healthy.\n\nWe haven't had to take drastic and dramatic measures to clear inventory like others, the retailers in the space have. We've got best-in-sector free cash flow generation. We continue to deliver best-in-sector store productivity. And our EBIT net income rates are higher than many in the sector.\n\nSo, I think we're in a good position to finish this year strong and the next year strong as we think about the plan for next year and beyond.\n\nDan Imbro -- Stephens Inc. -- Analyst\n\nReally helpful color. And then, I guess just a follow-up on that. You know, Mike, I know you guys were private during the Great Recession. But could you provide any color of just in case study of the kind of benefit you saw from the trade-down? It sounds like you guys are bullish that you'd see your everyday value offering maybe helped take share.\n\nCan you help quantify what you've seen during past downturns and the data you have on that?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nNo doubt. None of these economic cycles look exactly like the other, but you try to draw some parallels from it. 2008, 2009, and 2010 were collectively very strong comp years for the company, and those were some tough years. This is a little bit different cycle and that consumer balance sheets are still relatively healthy.\n\nThat won't last for a heck of a lot longer if inflation rates continue to rise and obviously go into recession. If that occurs, we are in a great position to pick up market share because we're the value player. I think what we've shown is our team, our customers, and our business are incredibly resilient through a variety of economic cycles.\n\nDan Imbro -- Stephens Inc. -- Analyst\n\nGreat. I appreciate all the color, and best of luck.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nThanks.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThanks, Dan.\n\nOperator\n\nOur next question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question.\n\nMegan Alexander -- JPMorgan Chase and Company -- Analyst\n\nIt's Megan Alexander on for Chris. Thanks for taking our question. You know, maybe I just wanted to follow up as well on an earlier question, you know, that three-year trend of 30% versus 2019. Has that at all improved throughout the quarter in November and into December? You mentioned weather not being helpful.\n\nIt's gotten a little bit colder, and then it does seem like there's a more normal cadence of holiday shopping this year. So, I'm just trying to understand, does that, you know, get any better especially as you move through Black Friday, which you mentioned was strong?\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nYeah. The 30% trend has been pretty consistent, you know, in the low to mid-30s for the past -- actually all this year. So, we have not seen a big shift. The one thing I will say is this holiday calendar, having lived through it multiple times, is one that you need to have somewhat of a lead stomach for because we are shifting from -- as Michael said, where people last year shopped early because of scarcity, and they're moving back to a later purchase pattern.\n\nSo -- and we're in line with that purchase pattern right now with our trends so far this quarter. But, you know, I think that trend for this year probably should continue. The first part of next year, as Michael said, the economy is still in a lot of turmoil. You know, it will continue to be a challenging -- will be a challenging time.\n\nBut we should be able to perform well at the higher base, as Steve talked about, you know, and continued to develop the business so that we can start growth, you know, at some point in the near future.\n\nMegan Alexander -- JPMorgan Chase and Company -- Analyst\n\nGot it. That's really helpful. And then, maybe a follow-up for Michael. How are you thinking about working capital and free cash flow generation for the fourth quarter? You know, one would think, based on the seasonality, that cash should become a source of funds in the fourth quarter.\n\nSo, you know, how should we think about a minimum cash balance as we think more about the potential for additional share repo in fourth quarter?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nNo. Great question. I think I will have one little nitpick before I get going here. We've got a business that's been performing so well, you know, we should generate cash in every quarter.\n\nAnd that, you know, hasn't been the case, I think, for a lot of other retailers and certainly us historically. But, you know, in the third quarter, which is typically not a source of cash, it was for us, while we were able to invest in the business. Correct. Fourth quarter, we should improve on that and grow the cash balance, and then we'll have to make some decisions like we've been saying.\n\nThere's no change to our approach. We generated enough cash, we can fund our initiatives, and we can take a portfolio approach to capital allocation, either through repurchases or potentially been retiring some debt, if we thought that was the right thing to do given where interest rates are headed.\n\nMegan Alexander -- JPMorgan Chase and Company -- Analyst\n\nGreat. Really helpful. Best of luck.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThank you.\n\nOperator\n\nOur next question comes from the line of Kate Fitzsimons with Wells Fargo. Please proceed with your question.\n\nKate Fitzsimons -- Wells Fargo Securities -- Analyst\n\nYes. Hi. Thank you for taking my question. I wanted to switch gears to margins.\n\nYou raised the full year gross margin outlook. Just as we're thinking about puts and takes on the gross margin into next year, how should we think about some of the drivers between mix, supply chain, promotions? And then, Michael, just any updated views on maybe the longer-term gross margin opportunity versus that 32.5% to 33% range you've spoken to previously, just given how well the business has held on to some of its margin gains? Thank you.\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nI'll take the first part, and then I'm sure Mike will jump in on some later parts. But so far, we're pretty pleased with our gross margin performance and our ability to hold on to the higher margins we generated over the past couple of years. We attribute a lot of that to just being better planners and managers of the business. That being said, you know, we do expect the margin will decline a little bit versus last year in Q4, which is accounted for in our guidance.\n\nThat's based off what we think it's going to be a more promotional holiday. We're already seeing it in a more promotional holiday, so we baked that in. But just to be clear, we're still going to hold on to the vast majority of those gains. And we think those gains are coming from a couple of different places.\n\nWe already mentioned the planning and allocation disciplines that we put in place in terms of better management of how we flow goods and allocate goods. We don't have the inventory overhang that I think a lot of other people out there have. So, that certainly is not going to be, you know, a pressure for us or a headwind for us. You know, one of the things that's happened to us during the pandemic was the hard goods business, which has a lower margin profile had become a bigger percent of total.\n\nAnd as that mix starts to normalize more back to a 50-50 soft goods to hard goods, that's definitely a tailwind for us as well. So, those are all probably the tailwinds. Certainly, the supply chain is getting better, but there's still some disruption in that. And I think that's something that could be a headwind for us.\n\nI think, you know, as business seems to be moving back to more kind of the cadence or trend pre-pandemic, I think we're going to see more promotions creeping in the marketplace. So, those would certainly be a little bit of a headwind. But we feel really good about our ability to navigate through those, and then we're going to hold on the vast majority of the margin gains we've picked up over the past couple of years.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nOK. First, welcome back. Good to have you on the call again. I want to tell you that look, Steve answered that one pretty well.\n\nI don't have a lot to add. Merchandise margins have been the hero as we continue to harvest the fruit from the initiatives and the groundwork we laid many, many years ago, and continue to do that. One thing that I would say, shrink has been a little higher than planned. There has been a lot of organized crime in retail.\n\nWe're experiencing that along with everybody else. We're working with our law enforcement partners who are great partners in part because they really like the stuff that we sell, and they love to shop in our stores. So, we think that we have an opportunity to improve that going forward. As far as the long-term algorithm, I'd stick with what you have and largely because we want to preserve flexibility if we need to become more promotional.\n\nWe want to preserve that flexibility.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nYeah. Two adds, Kate. One is we want to continue our value proposition, and so we do not want to forfeit growth for margins. So, we will work to maintain that value proposition that we've worked very hard to get and the customer views us within the market.\n\nThe other thing, I think, that is different when we talk about promotions, I think one, we talk about seeing more, but it is more rational and thoughtful for a couple of reasons. One, the people are in a better position and can afford to be more thoughtful about the promotions they had and had the ones back in that make the most sense to drive traffic. And two, the vendors -- what the vendors have done -- some of the key vendors have done over the past several years -- and it's not just in apparel, but it's in other places and how they've cut back on their distribution. And our positioning as a favored retailer for them have helped to maintain some of the sensibility in the market and also support some of the margin improvements that we've seen in addition to the operational and process improvements that we put in place.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nOne more thing to add, just as a reminder, we are just embarking on a multiyear initiative to improve the efficiency and the effectiveness of our supply chain. And that work is really getting underway. And so, I think from a market perspective, hopefully, the environment normalizes from a logistics and a supply chain perspective. But we have things to work on and our into that should provide a margin benefit in the out years.\n\nBut I think for now, you've got a good number to work with that we've provided in the past, and I think that's a good one to run with.\n\nKate Fitzsimons -- Wells Fargo Securities -- Analyst\n\nGreat. I'll let others kick it up in the queue, but happy holidays, guys.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nYou, too.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nOK. Thanks. You too, Kate.\n\nOperator\n\nOur next question comes from the line of Robbie Ohmes with Bank of America. Please proceed with your question.\n\nRobbie Ohmes -- Bank of America Merrill Lynch -- Analyst\n\nHey. Good morning. Just a couple of quick follow-ups. Just on the guidance, how are you thinking about transaction expectations in the fourth quarter? Kind of similar to the third quarter? And is, you know, some of the confidence as you just -- with hunting, not being less of a drag in the third quarter, you know, helps the visibility in the fourth quarter? And the kind of follow-up question, which you've somewhat answered, but just the -- you guys see promotions potentially coming back on and transactions have been down.\n\nYou know, how did that -- that, usually, is a hard environment to get gross margins, you know, up or flat versus all-time highs. You know, what's the risk of promotions come back on and you're not able to maintain the sort of gross margin expectations you guys have put out there?\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nYeah, I'll start and then let Steve pick up on the second part. Our transactions have been off. And the part of it is what's happening in the consumer environment. But part of it is also -- and it's actually a significant part of actions that we took last year.\n\nAs we said, there were limitations on ammunition. And while we sold a lot, we had limits on how many people could buy, and we had a lot of customers coming in multiple times in a day and, you know, literally lining up coming in every day. And we aren't seeing that now because we've taken those limits off. And that makes the transaction number a little bit more difficult to read year to year because we had created some artificial high transaction levels because of those limits that we've put on, and we no longer have those.\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nYeah. And to the point on promotions, you know, I think Ken was alluding to it. When you go back and you look at some of the promotions that we used to run pre the current management team being here, I mean, they were, in some cases, irrational promotions. And I think you've heard us talk about those over time where we'd be selling something like a big bulky item, like a trampoline close to cost, and then on top of that providing free shipping.\n\nAnd they just -- they didn't make a ton of sense. And so, I think one of the things that's happened over the past couple of years is -- not only for us but for the whole industry is the promotional landscape has kind of been benign. It's allowed us to kind of clear the decks, and it's really allowed us to be thoughtful about where and when and how we're layering in those promotions. You also have, you know, a lot of the vendors out there having much better control over their maps.\n\nSo, I think that kind of keeps them in check. So, I think it's the combination of us having rational promotions that we're not up against that we don't feel compelled to anniversary that drove top line but maybe not bottom line, coupled with a, you know, better controlled distribution out there. I think those two things allow us to know that we're going to see more promotions certainly this year than we did last year but that we're still going to be able to hold on a majority of the margin gains.\n\nRobbie Ohmes -- Bank of America Merrill Lynch -- Analyst\n\nAnd just a quick follow-up. In the average transaction size, are you seeing, you know, more items, you know, per basket? Or are you seeing, you know, bigger ticket purchases. And is there any -- have the vendors raised price on somewhat like items? So you're seeing, you know, inflation in certain categories like fleece or things like that that are supporting same-store sales?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nRobbie, I would just say that we generally don't give the basket detail. I'll give you a little bit of color. Last year, if you remember, we were up against a tremendous surge in demand for ammunition, and that drove a lot of units. And so, there's a little bit of noise kind of internally, but that will provide you a little color about our basket.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nAnd we are seeing some AUR increases just based on cost increases that we've seen out there.\n\nRobbie Ohmes -- Bank of America Merrill Lynch -- Analyst\n\nGot it. Terrific. Thanks so much.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThanks, Robbie.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nThank you.\n\nOperator\n\nOur next question comes from the line of Anthony Chukumba with Loop Capital Markets. Please proceed with your question.\n\nAnthony Chukumba -- Loop Capital Markets -- Analyst\n\nGood morning. Thank you so much for taking my question. I'm glad to hear my equipment is working. I try to get into an earlier call.\n\nThey didn't take my question. So, I thought maybe it was a problem on my end. Anyway, neither here nor there. Yeah, so, I had a question actually about your new store openings.\n\nI know it's fairly early, but these other first new stores you've opened in quite some time. And so just wanted to see if you -- you know, any early reads on how those stores are performing relative to your expectations? Thanks.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nFirst off, Anthony, if you couldn't ask a question on the last call, we'll let you ask us two. So, you can ask us two. We're happy to take it.\n\nAnthony Chukumba -- Loop Capital Markets -- Analyst\n\nThank you.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nYeah, new stores. I would say this year was really about capability building in test and learn. And so, we have all nine stores opened this year. We tried different formats, different markets.\n\nWe did urban stores, we did takeover spaces. We did traditional build-to-suits, and we tested a lot, and we learned a lot, and we build the capability. All nine stores are open. We're happy with the performance as a whole overall.\n\nThere's always things when you're testing and learning that you want to do different and do better, and we'll apply those learnings next year. So, we opened four new stores in Q3, two more in Q4. We haven't announced our targets next year, but it will be more than we did this year.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nOne thing, Anthony, I think, that's important, as Michael said, we are pleased with the overall performance, and we have some really good winners. We have, you know, a store that we would like for it to be better, and it's a good learning store. But one of the things that's actually, you know, really pleasing for us is some of the new markets that we've entered, both that were adjacent or completely new markets, we've seen some very good results there. So, we're getting some -- we're pleased with our ability to enter places where people might not be as familiar with us.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nThe last store on the last two we just opened in Barboursville, West Virginia, not only a new market. It's a new state. And I got to tell you, a line around the block in the snow. I'm sure if you followed us a little bit on social media, you've seen some of that.\n\nThat is exciting and shows the potential of not only, you know, being able to ability to grow in that market. But in that region, where there's a lot of white space for Mid-Atlantic.\n\nAnthony Chukumba -- Loop Capital Markets -- Analyst\n\nGot it. Very helpful. And then, once again, thanks for allowing me to ask a second question to make up for the fact that I wasn't able to ask any question on the earlier call. So, yeah, just a real quick one.\n\nYou know, you mentioned supply chain and some of the improvements you're going to be making there. Michael, if I recall correctly, when we had last spoken, you said that you thought that the warehouse management system would be installed in 2023. I just wanted to confirm if that was still the case or what your thought was there.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nThat's going to be a multiyear. But yes, I think toward the end of 2023, we'll start to bring that online.\n\nAnthony Chukumba -- Loop Capital Markets -- Analyst\n\nOK. Very helpful. Thanks, and keep up the good -- go ahead, sorry.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nAnd just to be clear, that's -- we will phase that in across all of our DCs. So, we're not doing anything all at once. So -- but we'll start at the end of '23 and then roll it out to other distribution facilities.\n\nAnthony Chukumba -- Loop Capital Markets -- Analyst\n\nGot it. Thanks so much. Keep up the good work, guys.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nThank you.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThank you. Thank you, Anthony.\n\nOperator\n\nOur next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.\n\nAndrew Chasanoff -- Oppenheimer and Company -- Analyst\n\nHi. This is Andrew Chasanoff on for Brian Nagel. I just have two quick questions. One is shorter term in nature and the other one is longer.\n\nIn the near term, can you call out any specific trends in the Black Friday, Cyber Monday specifically, how you describe the brick-and-mortar traffic trends versus pre-COVID? And then, longer term in nature, as the pandemic dynamic is decided, has your thinking toward a longer-term growth algo of ASO changed at all? Thank you.\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nI'll take the first part. I'll give the second part to Michael. You know, one of the things we've seen this Christmas, candidly, that started in early November and blend in the Black Friday week is kind of a return to pre-pandemic shopping patterns. So, what is -- what we mean by that is, if you go back, you know, pre-pandemic, customers really waited until Black Friday week to kick off.\n\nThe last two years, we've seen pull-forward of demand early in the month, particularly in some of the bigger ticket categories where there was scarcity of supply. And so, we've seen that kind of revert back this year. So, softer demand for big ticket early in the month. Then, when we got into Black Friday week, another thing we've seen is people, over the past couple of years, were really trying to avoid large crowds on Black Friday itself.\n\nThey tended to shop earlier in the week. And then, we saw a little bit softer trend over the weekend. And that's reverted back to where the weekend was much more important this year. And as Ken mentioned already, it was the largest day in our company's history from a sales perspective.\n\nSo, I would say the biggest thing we've seen is kind of reversion early on back to more of the soft goods business. We've seen it shift back to their shopping on the big days, more pre-pandemic than where they have been. But we also believe that that's going to drive the big ticket sales closer in, which we've seen pre-pandemic as well.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nOne of the other things we did see, though, was the customer was willing for the right item to buy the big ticket. So, we -- this is not -- it was not -- Black Friday was not just driven by apparel. We did very well in that. But we also saw a number of our big ticket items, some of the categories that Michael called out, like outdoor cooking, sports, and the like, also performed very well during the event.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nWhere we had great value.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nWhere we had good value.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nWith respect to the long-term growth algorithm, no changes there. I mean we're still planning low single-digit comp growth overall throughout the long-range plan. Total sales growth of high single digits, EBITDA growth at high single digits, and net income growth in the high teens. We will do that for the addition of 80 to 100 new stores investing in our dot-com business, which is out on a real growth run here, continuing to grow at double digits quarter over quarter and improving our existing operations.\n\nAndrew Chasanoff -- Oppenheimer and Company -- Analyst\n\nGreat. Thank you so much.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThanks, Andrew.\n\nOperator\n\nOur last question comes from the line of John Zolidis with Quo Vadis. Please proceed with your question.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nHi, guys.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nHey, John.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nThanks for taking my question. I have two questions, but I'll just stick with one here since it's the last one. You mentioned that you had --\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nYou can ask two.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nOK. Thank you. All right. So, here's my two questions then.\n\nFirst question is on average unit sales. So, for the full year, we're looking at just under, I believe, $25 million per average store. And that's down about from a little over $26 million in the previous year. And so, the first question is, for the new units that are coming on, what do you expect those to annualize in their first year?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nJohn, I'm sorry, I missed the last piece of your question.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nSo, the newer stores that you're opening up. We've got nine open year to date, as you've mentioned. They haven't been open a full year yet. But as we think about the sales contribution from the new stores, what should they be annualizing at in their first year?\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nWe underwrite them on average of around 16 million at year one sales -- end of year 1 sales. We do expect them to be EBITDA-accretive after year one. Again, some of these just opened, but the first four, collectively, as a whole, were more accretive to earnings, even, you know, just a few months into the year from their opening.\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nThen, obviously, they ramp up on [Inaudible] basis.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nYes. They ramp. Yup.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nYes, significantly higher than a typical store.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nOK. Thanks. We will monitor that. And then, the second question relates to something you talked about with pandemic winner categories.\n\nAnd you mentioned that a number of these, even though they might be down a little bit, are still dramatically higher than pre-COVID levels and in particular, for example, ammunition still up triple digits. So, I think a more cautious view might suggest, hey, these are still performing OK, but what we really just haven't seen the reversion or in the demand for these categories yet. And as we go into next year and potentially less favorable consumer environment, that's where you're going to see this kind of continued downward pressure. And so, obviously, we can't predict what's going to happen.\n\nBut my question is, how are you positioned -- how are you able to manage inventory if that were to occur?\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nWell, I think we've demonstrated that over the past several years, to be honest with you. You know, we certainly build contingency plans into our buying process. We have trigger dates that we activate depending upon where we see demand happening. We have great partnerships with our vendor partners.\n\nAnd I think on both sides of it as inventory was scarce, and we had to chase it. I think we definitely outperformed a lot of our competitors in terms of getting supply of goods, which I think was reflected in sales trend that we drove in '20 and '21. And I think this year, as the supply chain has gotten a lot better, and actually, a lot of them just caught up, some people have been caught the other way with inventory ballooning for them. And I don't think we've seen that happen.\n\nSo, I think we've got a very nimble team, who's got good partnerships and relationships, a strong planning and allocation basis, strong open-to-buy management. And that's really allowed us to manage on both sides of it. So, I don't see that changing if we see a slowdown next year. But what I would say is, you know, one of the things that gives us confidence, and I think Michael hit on this, is, you know, these search categories, we track them.\n\nYou know, you mentioned several of them, we talked about animal being one, or fitness being another, you know, or cooking or things like that. You know, they're all stabilizing at these higher levels. In a lot of cases, higher than the 30% trend that the company performed at. And we're seeing the volumes stabilize at those levels.\n\nSo, that's another thing we're looking at, not just the trend versus last year, but the average weekly volume, the average monthly volume. And so that's giving us confidence that this is kind of the new baseline that we're building off of because they've been maintaining at those consistent levels for multiple quarters in a row.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nTwo other things that I think are very important about this category and the inventory. First, as Steve mentioned, I think we have absolutely demonstrated we can manage inventory as well, if not better than most anybody in the space. But the categories where, you know, if you take a bearish view, and you predict a demand drop-off, the inventory doesn't go bad. It's not seasonal in nature.\n\nIt doesn't become toxic like seasonal apparel inventory does. Secondly, in these categories, while if you believe they're going to be demand=challenged, they shouldn't be share-challenged because a lot of folks in this space have walked away for it, and they don't support it. Like, they used to. And so, we should continue to take share even if the category becomes demand-challenged.\n\nAnd again, the inventory will remain healthy because it doesn't -- it's not subject to fashion or seasonality or those types of things.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nYes. My line is they're not bananas. But one of the key things here, John -- or two key things. One is what Steve mentioned that these -- the team has demonstrated the ability in multiple scenarios to manage the inventory, not put us in a position.\n\nWe haven't announced as other retailers have that we've got an inventory problem, and we're having to take excess markdowns. We are managing carefully where we are, both on the up and downside. And the second thing is we've also demonstrated that we are able to maintain at those higher levels. And one of the comments that Michael just made was about -- even some of those categories that are declining, our share continues to improve in many of those categories.\n\nSo, we're able to, while in a declining market or in a declining situation, pick up share and hold at that higher level, either because competition has pulled back or the value and assortment that we've offered. Our team has done an excellent job over the past couple of years, putting us in a good place with our good, better, best strong brand assortments in multiple categories. And so that is one of the things that gives us confidence as we go forward that, yes, we're in tough times; yes, you know, the first part of next year is going to be, you know, a challenging time for not just retail, but the entire economy. But we will be positioned for growth both with our existing stores and online, but also as we enter new markets.\n\nSo, we feel very confident about our position going forward, and we're excited about the future for Academy.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nThanks very much, and happy holidays to everyone and your families.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nThank you, John.\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nYou, too. Thank you.\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nThank you.\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nOK. That was our last question. We're ending right on time, and I appreciate everybody's participation on the call. Thank you very much.\n\nAppreciate everybody's support of the company. I want to thank all of our team members, but also our investors and the people who are interested in Academy. We feel, as I said, we've got a great future. I want to wish everybody the happiest of holidays and a terrific, terrific new year.\n\nSo, happy holidays, and thank you. Goodbye.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nMatt Hodges -- Vice President, Investor Relations\n\nKen Hicks -- Chairman, President, and Chief Executive Officer\n\nMichael Mullican -- Executive Vice President and Chief Financial Officer\n\nSteve Lawrence -- Executive Vice President and Chief Merchandising Officer\n\nJohn Heinbockel -- Guggenheim Securities -- Analyst\n\nDan Imbro -- Stephens Inc. -- Analyst\n\nMegan Alexander -- JPMorgan Chase and Company -- Analyst\n\nKate Fitzsimons -- Wells Fargo Securities -- Analyst\n\nRobbie Ohmes -- Bank of America Merrill Lynch -- Analyst\n\nAnthony Chukumba -- Loop Capital Markets -- Analyst\n\nAndrew Chasanoff -- Oppenheimer and Company -- Analyst\n\nJohn Zolidis -- Quo Vadis -- Analyst\n\nMore ASO analysis\n\nAll earnings call transcripts"}
{"id": "00388844-8083-47aa-866c-85a9d000ecb4", "companyName": "RBC Bearings", "companyTicker": "ROLL", "quarter": 1, "fiscalYear": 2023, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/04/rbc-bearings-roll-q1-2023-earnings-call-transcript/", "content": "RBC Bearings\u00a0(ROLL -1.32%)\nQ1\u00a02023 Earnings Call\nAug 04, 2022, 12:00 p.m. ET\n\nOperator\n\nHello, and welcome to the RBC Bearings Q1 fiscal year 2023 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Josh Carrell, investor relations. Please go ahead.\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nThank you, Josh, and good morning all. I'll start off by saying that net sales for the first quarter of fiscal '23 were $354.1 million versus $156.2 million for the same period last year, an increase of 126%. For the first quarter of '23, sales of industrial products represented 72% of net sales, Aerospace products, 28%. Gross margin for the quarter was $141.2 million, 39.9% of net sales, compares to $63.8 million or 40.8% for the same period last year.\n\nAdjusted operating income was $68.3 million, 19.3% of net sales compared to last year of $29.9 million and 19.1%, respectively. The AD EPS was $1.09 and new adjusted EPS came in at $1.79, and Rob will explain this in more detail later in the call. The quarter performance was very much in compliance with our expectations, right in the middle of the fairway. A little lower on revenues than our guidance as a result of losing $6 million to $10 million from the shutdown of our Shanghai China plant and some unusual missteps by a forward freight manager.\n\nAdjusted EBITDA for -- was $100.7 million, 28.4% of net sales, compared to $45.3 million, 29% of net sales for the same period last year. During the period, we paid down debt by another $125 million and free cash flow was $51.2 million. We entered the first quarter with a strong industrial sector. All components, including industrial distribution, food, aggregate, grain, mining, semiconductor machinery, marine, wind, energy were strong, and the outlook here is more of the same for the next quarter.\n\nSales of industrial products were up by 286.8 from last year. RBC organic growth for industrial products was up 17.3%. Turning now to aerospace and defense. The first quarter of fiscal '23, net sales were up 10%.\n\nThe revival in production at Boeing is a welcome contributor, as their plans to increase rates on the MAX to over 500 and 600 ships in '23 and '24, respectively, from 330 today and Airbus sets a new pace of 700 and 800 ships for the A320 series over the same period. Today, there are -- they ship -- they plan on producing 600 ships. This brings a new and welcome post-COVID volume to our factories, many of which were designed and capitalized over the past half dozen years to efficiently produce products for these important aircraft models. As many of you already know, RBC Bearings was honored to receive the Supplier of the Year award from Boeing at their June Supply Chain Conference in Los Angeles.\n\nWe have been a supplier to Boeing since the 1940s, probably earlier and participate in every plane model currently produced and a great many defense products. Boeing commercial aircraft is supported today by over 11,000 suppliers. The release to production of the Boeing 787 model aircraft is an important milestone event for us. Several of our plants produce many unique products for this plane, and our content is substantial.\n\nObviously, we are applauding the resumption of production of this aircraft and are busy now reviewing plant capacity to support the increase. We are using 10 ships per month in 24 months out as a planning boogie. A word on our defense business, the outlook here is positive for new designs, hardware and services, new designs for advanced munitions, aircraft and submarines with expanded mission profiles. It's very active right now, and it's a pretty exciting place to work.\n\nOur business supporting the construction of Virginia and Columbia ships continues to expand, and we plan to add to our manufacturing and test facilities, over the next 24 months to support these requirements for the next at least a dozen years. More on this aspect in future calls. Finally, given the deployment of U.S.-made equipment to Europe in the past month, there's been a strong initiative underway here for replenishment of munitions. As you can imagine, we will be impacted by that.\n\nRegarding the second quarter, we are expecting sales to be between $355 million and $365 million. The art here in that range is all about supply chain. And now I'll turn the call over to Rob for more detail on the financial performance.\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nVP & CFOThank you, Mike. SG&A for the first quarter of fiscal 2023 was $55.8 million compared to $31.2 million for the same period last year. As a percentage of net sales, SG&A was 15.8% for the first quarter of fiscal 2023 compared to 20% for the same period last year. Other operating expenses for the first quarter of fiscal 2023 totaled $20.9 million compared to $3.2 million for the same period last year.\n\nFor the first quarter of fiscal 2023, other operating expenses included $17.3 million of amortization of intangible assets, $3.8 million of costs associated with the Dodge acquisition and $0.2 million of other income. For the first quarter of fiscal 2022, other operating expenses consisted primarily of $2.6 million of amortization of intangible assets and $0.6 million of restructuring costs and other items. Operating income was $64.5 million for the first quarter of fiscal 2023, compared to operating income of $29.3 million for the same period in fiscal 2022. On an adjusted basis, operating income would have been $68.3 million for the first quarter of fiscal 2023, compared to adjusted operating income of $29.9 million for the first quarter of fiscal 2022.\n\nInterest expense for the first quarter of fiscal 2023 was $15.8 million, including $2.3 million associated with the amortization of deferred financing fees. This compares to interest expense of $0.3 million for the same period last year. The year-over-year increase reflects the addition of the term loan facility and the senior notes utilized for the Dodge acquisition during fiscal 2022. For the first quarter of fiscal 2023, the company reported net income of $37.4 million, compared to net income of $24 million for the same period last year.\n\nOn an adjusted basis, net income was $40.2 million for the first quarter of fiscal 2023, compared to $24.3 million for the same period last year. Net income available to common stockholders for the first quarter of fiscal 2023 was $31.7 million compared to net income of $24 million for the same period last year. On an adjusted basis, net income available to common stockholders for the first quarter of fiscal 2023 was $34.5 million, compared to $24.3 million for the same period last year. Diluted earnings per share was $1.09 for the first quarter of fiscal 2023 compared to $0.95 for the same period last year.\n\nOn an adjusted basis, diluted earnings per share for the first quarter was $1.19, compared to adjusted diluted earnings per share of $0.96 for the same period last year. Starting this quarter in future releases, we reflect a newly defined adjusted earnings per share. In recent months, it's become clear everyone is a bit all over the place and how they're considering earnings per share, and we have listened to feedback from our shareholders, and we believe this new metric will best reflect the ongoing performance of our business. To be clear, in future periods, we will no longer report cash earnings per share or our historical adjusted earnings per share, which only considered foreign exchange, discrete and other unusual tax matters and other nonrecurring or unusual items.\n\nThe new adjusted earnings per share will reflect adjustments for onetime or unusual items, foreign exchange, discrete and other unusual tax matters, amortization of M&A-related intangible assets, amortization of stock-based compensation and the amortization of deferred financing fees. For the first quarter of fiscal 2023, this new adjusted earnings per share was $1.79, compared to $1.22 for the same period last year. This year-over-year improvement reflects the significant benefits provided by the Dodge acquisition. Please refer to our press release filed this morning for the full calculation.\n\nTurning to cash flow. The company generated $59 million in cash from operating activities in the first quarter of fiscal 2023, compared to $53.3 million for the same period last year. We made a strategic investment in our inventory during the current period, which impacted the operating cash generation. Capital expenditures were $7.9 million in the first quarter of fiscal 2023 compared to $3.4 million for the same period last year.\n\nWe paid down $125 million on the term loan during the period, leaving total debt of $1.565 billion as of the end of the period and cash on hand was $119.6 million. Finally, I wanted to offer some brief details on the restatement of our 10-K previously filed in May. This restatement arose out of the company's reexamination of the timing of the recognition of stock-based compensation expense associated with certain executive awards. Under U.S.\n\nGAAP, the recognition of compensation expense associated with these awards should have been accelerated due to certain clauses in the agreements associated with voluntary termination. The results of these adjustments is an expense that would have previously been recorded in fiscal 2023 and future years has been recorded in previous periods. The impact in fiscal 2022 was an additional $9 million of pre-tax compensation expense. The impact in fiscal 2021 was a reduction in expense of $3.2 million and the impact in fiscal 2020 was an additional $7.4 million of pre-tax compensation expense.\n\nImportantly, these adjustments relate to a noncash expense item and impact the timing of the recognition rather than the overall amount of the compensation expense. There was no impact to our historical non-GAAP adjusted EBITDA as we traditionally exclude stock-based compensation from that metric. As a result of these adjustments, the total expense recognized in fiscal 2023 is expected to be less than previously anticipated, including a reduction of more than $5 million for the total for the rest of the fiscal year. I would now like to turn the call back to the operator for the question-and-answer session.\n\nOperator\n\n[Operator instructions] Our first question today is coming from Kristine Liwag from Morgan Stanley.\n\nKristine Liwag -- Morgan Stanley -- Analyst\n\nSo first, congratulations on winning the Boeing Supplier of the Year Award. Presumably, Boeing would want more of a supply chain to execute like you guys. I mean, to what degree does this recognition potentially unlock expansion of scope of work?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nWell, we're waiting to see how that plays out, Kristine. It -- we're clearly sort of in the winner circle in terms of new work coming from Boeing. And so we're working through bids on other products. Boeing is, I guess, it's well known that they have a lot of supply chain issues and suppliers that didn't make it through the COVID period for financial reasons or employment reasons or shortage of labors.\n\nAnd so they're looking to move work. And I think we're probably in a very good position to achieve some of that work, too early to tell what the ultimate benefit is going to be -- but I like where we are.\n\nKristine Liwag -- Morgan Stanley -- Analyst\n\nAnd if I could do a follow-on question on Dodge. When you look at RBC Bearings historically, you guys have performed and been very defensive across different cycles. I mean, looking back in the past 10 years, gross margins didn't dip below 35%. And even going back to data post IPO, I mean gross margins never dipped below 30%.\n\nSo given the uncertain macro backdrop we're facing today, can you provide more color on how Dodge changes your -- the defensibility of your portfolio and how you'd expect them to perform in an industrial recession, should we see one? I mean, with the 60% recurring revenue at Dodge, is it more or less defensible on top and bottom line versus RBC bearings on a legacy basis?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes. Well, I think roughly 80%, I'm rounding now, of Dodge's revenues are coming from industrial distributors. And those industrial distributors, if you talk to any one of those industrial distributors, they will tell you that 50% of their revenue is what they call break fixed revenue. So there's something broken in one of the plants that they service.\n\nAnd so they supply the replacement part to that plant. And so a heavy -- there's a heavy concentration of Dodge's business is associated with this break fix component of the U.S. infrastructure. And that infrastructure is aggregate, it's grain, it's a what they call unit handling.\n\nAnd so it's very integrated into -- into the U.S. GDP. So I think that Dodge -- when you look at the Dodge revenues over that same period, they're lower beta revenues than RBCs because RBC is more direct OEM business, so we might be supplying somebody like a Caterpillar and depending upon what systems you're supplying at Caterpillar, you can be up a lot, you can be down a lot. And Dodge doesn't have that variability in their makeup.\n\nKristine Liwag -- Morgan Stanley -- Analyst\n\nAnd then with less of that variability in the top line, presumably, margins also would be more stable. Is that a fair assessment?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes. I think that's a fair assessment.\n\nOperator\n\nNext question is coming from Steve Barger from KeyBanc Capital Markets.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nRob, thanks for the explanation on the new adjusted EPS. Just to make sure I understand, when you report 2Q, we'll see a GAAP result and then the adjusted number that you will focus people to be comparable to the $1.79 that you referenced for this quarter?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nThat's exactly right. Those will be the only 2 that will reflect starting next quarter.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nSo you would expect consensus to reflect more of that 179 basis.\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nThat would be what we would expect.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nI'm going to ask that industrial question maybe in a slightly different way. When you think about the combined industrial business and how that will grow relative to the cycle, just to be more quantitative, if IP or industrial production is plus 5%, what would you expect your business to be up? And then same question, if IP were to be down 5%.\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nYes. Well, I can tell you, if IP were up 5%, we would have difficulty supporting all the order book -- year book would be extremely demanding. Actually, when it's above 3%, it's very demanding. 5% that's probably merges with a purchase manager index of something like 55 to 58.\n\nThat's -- those kind of track each other -- in those neighborhoods, we're as busy as it can get. When it goes negative 5%, Steve, I really don't want to think about that.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nWell, I mean, you just went through it in the pandemic, right? And IP is running about 5% right now. So is the order book hard to keep up with, as it stands today? [Inaudible] not withstanding?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes. So the order book is still outpacing our ability to deliver. And that's mainly a supply chain thing. We certainly have the internal plant capacity, but we are having hiccups, particularly in the Dodge side, not on the RBC side, but on the Dodge side with supply chain matters.\n\nAnd that way, when we do a revenue guidance, there's an incredible amount of work that goes into the calculus associated with getting to those revenue numbers. And so we try to make them conservative but realistic. And so if there's some supply chain breakthroughs, then there'll be a very pleasant revenue surprise at the end of the quarter. The supply chain problem is getting better as we bring on basically additional suppliers.\n\nAnd in some cases, we convert some of the RBC classic plant manufacturing to relieve some of the shortages that we have. So -- and that's working better as you introduce it and work it and it matures. So I think -- but I do think it's going to be with us for the rest of this year.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nYes. For the revenue guide for 2Q, how much did you factor in as an offset for supply chain?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nWell, I know what the number is, but I don't want to tell you.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nOK. Is it less than you factored in for your 1Q guidance?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nNo. It's the same.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nOK. And do you expect Dodge revenue contribution will be up sequentially?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nYes. I do.\n\nOperator\n\nNext question is coming from Seth Weber from Wells Fargo Securities.\n\nSeth Weber -- Well Fargo Securities -- Analyst\n\nI wanted to ask, the margins were actually better than what we were looking for, both on the gross margin and EBITDA margin. So I'm just trying to understand maybe where you're at from a price cost perspective, would you expect price cost to be getting better through the balance of the year? Are you on the positive side of that? Or just any framework you can give us for what you saw in the first quarter relative to expectations for the rest of the year?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nYes. Well, I think price cost is going to get better, particularly as it relates to supply chain and half of Dodge's cost of sales in rough numbers, our supply chain. -- supplied. And so there's transportation expense in there.\n\nIn the past quarter, there is air freight from Asia there. That's going away. The cost of diesel is -- seems to be moderating. So the transportation expense should calm down.\n\nAnd we see the prices of some of the basic commodities backing off. So that's telling us that, that cost pressure should be relieved as time goes on. We didn't see -- see any relief in the first quarter. So we're not planning to see any material relief in the second quarter.\n\nSeth Weber -- Well Fargo Securities -- Analyst\n\nOK. Would you keep the price increases that you're pushing through even in a lower input cost environment?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nWell, I mean, we'd have to evaluate it product by product and account by account and see where it all comes out. It's -- that's a hard question to answer. We would, in some cases, and we'd probably back down in other cases. And so it's very tactical.\n\nSeth Weber -- Well Fargo Securities -- Analyst\n\nOK. And then just my follow-up question. You've mentioned now for a couple of quarters adding capacity on the Aero side. And I think I heard you kind of referenced adding some capacity on the defense side as well.\n\nCan you just put some timing around that. It sounds like defense may be a little bit further out. But when would you expect this extra capacity to start to help you?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nWell, on the aero side, we don't have to add the capacity on the Aero side in terms of capex and that sort of thing because we were at a gallop there before the pandemic hit. And we want to get sort of -- it looks like we're going to get back into those close. So it's really adding manpower and that's -- these days, that's not easy to do, but it's doable. And so you have to go out and be creative about where you look for people and how you attract them to your company.\n\nSo that's on the aerospace and the industrial side, that's kind of answers that question. On the defense side, yes, it's a little further out. We have proposals into the -- some of the defense agencies with regard to what we'd like to add for what we think should be added for capacity. And they've been favorably received, and it looks like we'll receive some funding.\n\nOperator\n\n[Operator instructions] Our next question is coming from Sam [Inaudible] from Truist Securities.\n\nUnknown speaker\n\nI was just hoping I think you touched on this a little bit regarding pricing, but is there any particular aspect of supply chain, whether it be specific parts or raw materials were you guys either increasing lead times or maybe some pressure there? And then kind of building off of that, again, briefly touched on prior. But regarding labor, are you guys finding any additional needs there for bringing on capacity on that front?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes. One, on the labor side, we definitely will, we'll have to add labor. This buildup of the 787 production volume is pretty significant for us. So there's no way that we're going to be able to do that without adding labor.\n\nAnd -- but it's a manageable amount of labor requirement. So it's -- the second part of your question was materials?\n\nUnknown speaker\n\nYes. Just if you guys are feeling any particular supply chain pressure, whether it be lead times or just some pressure and whether it's any particular parts or raw materials when you might be feeling that?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nWell, yes, on raw materials, of course, it's titanium. And titanium is always an issue. And depending upon who you're working for, it can be a challenge. It could be very costly.\n\nAnd so there's various strategies that we can employ there and do employee, we can buy -- if we're supplying Boeing, we can buy titanium from the suppliers at a negotiated price that Boeing had negotiated with that supplier for people like us. And Boeing tells us there's absolutely no issue at all with the availability of titanium that got that covered. So I hope they're right. Now with regard to some steels, some of the steels are pretty exotic and pretty sophisticated and lead times and some of the steels are out a year, 50 weeks.\n\nSome of the important steels are made by people who went bankrupt, and are barely staying alive. And so some of the big plane makers and their subcontractors, larger subcontractors are doing some extraordinary things to keep those people alive, but that's always a concern.\n\nOperator\n\nYour next question is coming from Joe Ritchie from Goldman Sachs.\n\nJoe Ritchie -- Goldman Sachs -- Analyst\n\nA few quick ones for me. I think I recall the last time we chatted, we were anticipating the first half gross margin to be about a 100 basis points higher than where you exited fiscal '22. It looks like the start to the year has gotten maybe a little bit -- gone off a little bit slower than expected or below the 4Q number. Do you guys still expect the first half GM to be about 100 basis points higher?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nSo yes, I think the way we're looking at is over the course of the year, we should start to see that improvement, but it's always lumpy during the year. I would expect the second-quarter gross margins to look quite similar to the first.\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nAnd our strongest quarter is Q4.\n\nJoe Ritchie -- Goldman Sachs -- Analyst\n\nAnd then, I guess, maybe just kind of parsing out, I know that you guys have a lot of international exposure, so probably less affected by FX than a lot of other companies that we cover. But I'm just curious, like the industrial organic growth number for this quarter, I don't -- I didn't hear you guys give it earlier. I mean, we're calculating something like 17%. Is that what you saw come through in the quarter?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\n17.3%. And that's mainly \u2013\n\nJoe Ritchie -- Goldman Sachs -- Analyst\n\nAnd then I'd actually be curious just to hear any trends that you're seeing in the business as you progress through the quarter? Obviously, 17% is a very healthy number. A lot of concerns out there around industrial activity slowing. Just any thoughts around what you're seeing in that business? And any trends that you saw intra-quarter?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nWell, I think we have a few really good key markets that are doing well, construction and mining, semicon, oil and gas. And at the same time, I think we're starting to see some activity from our synergy on cost training, Dodge's sales team and RBC sales team. And so with a 17.3% growth rate on industrial mainly in the U.S., I mean, we'll more than double of any of our competitors on the growth for year-over-year for the quarter that we're going up against. But for us, the big markets, like I said, are construction and mining side be the Caterpillars, commodities of the world, oil and gas, semiconductor, general industrial distribution.\n\nJust without Dodge, our General industrial distribution business was up 11.6% and organically, and our OEM business was up 21%.\n\nOperator\n\nYour next question is coming from Ron Epstein from Bank of America.\n\nRon Epstein -- Bank of America Merrill Lynch -- Analyst\n\nSo just a couple of quick financial questions. So is the plan to still pay down $300 million of debt this year?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nThe plan is to accomplish $300 million this year, $400 million cumulatively since the acquisition. That's right.\n\nRon Epstein -- Bank of America Merrill Lynch -- Analyst\n\nAnd then I guess another thing that kind of came out in release me what's being done to address the material weakness in the financial controls?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nYes. We're taking it internally. We are reevaluating the processes that are in place regarding employment contracts as they relate to compensation and we'll be adding additional controls regarding the legal and accounting review prior to the time of grant.\n\nOperator\n\nThe next question is a follow-up from Steve Barger from KeyBanc Capital Markets.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nWas there anything outside of Shanghai and supply chain that impacted 1Q revenue? Like was there any FX impact?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nVery minimal FX impact during the period, all things considered. Obviously, the European rates moved the way they did, but the notes that Mike hint on were the bigger drivers.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nCan you remind me, if anything changed around seasonality for 3Q with Dodge included? I think historically, it typically steps down a touch from 2Q before the ramp to the 4Q peak.\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nThe same. So you can expect they're going to have the same holiday seasons that we have, Thanksgiving, Christmas and the shortest amount of production days for both companies.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nAnd historically, ROLL's been really good at taking an analytical approach to things. So as you look across your end markets and your existing customers, do you see more value right now in going after more wallet share or in entering new markets? Because presumably, the former has a higher returns than the latter.\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nWell we have a lot of new products coming through the system, almost too many in terms of I mean, you can't get behind all of them. And you have to pick the big winners. And so right now, as far as Dodge is concerned, we're sorting through what they have for product development, which is extensive. And which products, how mature are their developments? How far along is the product technically and how far along are we in terms of understanding the market needs.\n\nAnd what's scalable in terms of those products. And that's the process that we're going through right now with Dodge. And it's -- I'll tell you, it's keeping us busy. There's a lot of -- lot of wood to cut there.\n\nAnd so I think in terms of adding new products to the existing market channels is a very good recipe for success, as it applies as -- certainly as it applies to Dodge. Now RBC on the other hand has, to a large extent, particularly in aerospace and defense, is completely different lineup in terms of customers and market channels. And so we've kind of gone through the RBC agenda over the years and know which ones are the -- are the ones at the back. And it's pretty much product introduction to existing markets.\n\nAnd then I think secondarily to that is how do you map RBC across Dodge's industrial markets, so that you're actually picking up revenue by introducing new accounts to existing products. So that's -- those are the two big waves on the stool that we're working on right now.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nAnd realistically, how long does it take to effectively complete that mapping process? Is that years or quarters?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nWe're quite -- well, I mean, it never ends, Steve. It really never ends because there's always more coming through. But we're quite far along on some of these programs in terms of Dodges' program. And so -- and others are at the initial stage at the end of their technical development, but at the beginning of their market assessment.\n\nSo yes, I think we're going to have some good things to talk about.\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nGreat. And just one more. Just looking at the segments, will aerospace always have intrinsically higher incremental margin than industrial? Or should they be even over time?\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nThey tend to be quite close over time. It obviously depends on the period and what's going on. But if you look at the history, they're really not that far apart.\n\nOperator\n\nYour next question is coming from Pete Skibitski from Alembic Global.\n\nPete Skibitski -- Alembic Global -- Analyst\n\nSorry. I've been getting trouble getting into the queue there. Yes, Mike. Maybe just to start, on the Shanghai plant is revenue-wise, has the plant reopened again as of the start of 2Q?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes. It has.\n\nPete Skibitski -- Alembic Global -- Analyst\n\nOK. So we should gain that revenue back. And then any would you guys be willing to quantify the impact of the -- I think you called it an unusual freight misstep in the quarter?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes.\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nIt was -- that impact was somewhere between $2 million and $4 million.\n\nPete Skibitski -- Alembic Global -- Analyst\n\nAnd the issue has been -- it sounds like a onetime issue?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nYes. It was -- it's an unusual issue for this particular forwarder. It hasn't happened in the past that anybody could remember. And so we're getting involved with why it happened this time and what we can do to help.\n\nPete Skibitski -- Alembic Global -- Analyst\n\nMaybe on industrial they kind of switch the metric a little bit from IP. In the past, Mike, you've talked about PMIs a lot and it's great when PMIs are about 55%, and we've seen a little bit of deceleration recently. So I'm just wondering, as we sit here in August over the last month plus, are there any signs of deceleration in demand at all for your industrial end markets? Or is it just not really something that's visible right now?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nCertainly, for classic RBC, we're definitely not seeing it. We're not seeing any acceleration in Dodge, it's -- their business is lumpy. And -- but when we look at the markets that they serve, aggregate -- in the aggregate market from what our field people are telling us, there's no capacity left by aggregate producers. They're a 100% full, and we have now this infrastructure program coming through that's going to throw gasoline on the fire.\n\nGrain is grain. It's going on in the world with grain. And so the farmers are running their machinery and breaking things and needing replacement. Our food products have been really well accepted by the industry.\n\nAnd that's a growth leg for us that's in its early stages. And we have been -- we have a lot of demand for these new products out of Dodge that address the manufacture of food. And so we think that those markets are going to continue. And we haven't seen them let up.\n\nWe have seen some backing off of what they call unit handling as a result of Amazon canceling building, what, 40 or 50 different warehouses. So there's been some back up there, but that's frankly, that's probably going to expand our margins.\n\nPete Skibitski -- Alembic Global -- Analyst\n\nLast one for me. I think you guys are still expecting to generate $400 million in adjusted EBITDA this year. Is that on track?\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nWell, certainly, with the first quarter, we're trending in that direction. Yes.\n\nOperator\n\nWe've reached the end of our question-and-answer session. I'd like to turn the floor back over to Dr. Hartnett for any further closing comments.\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nOK. Well, I appreciate the involvement of everybody in the questions today. And thanks again for your interest in RBC Bearings and participation in the call, and we'll speak again in October. Good day.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nMichael Hartnett -- Chairman, President, and Chief Executive Officer\n\nRob Sullivan -- Vice President, Chief Financial Officer\n\nKristine Liwag -- Morgan Stanley -- Analyst\n\nSteve Barger -- KeyBanc Capital Markets -- Analyst\n\nSeth Weber -- Well Fargo Securities -- Analyst\n\nUnknown speaker\n\nJoe Ritchie -- Goldman Sachs -- Analyst\n\nRon Epstein -- Bank of America Merrill Lynch -- Analyst\n\nPete Skibitski -- Alembic Global -- Analyst\n\nMore ROLL analysis\n\nAll earnings call transcripts"}
{"id": "00388a65-6787-4561-8de1-cec5cdeada21", "companyName": "DuPont de Nemours, Inc.", "companyTicker": "DD", "quarter": 1, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/05/03/dupont-de-nemours-inc-dd-q1-2022-earnings-call-tra/", "content": "DuPont de Nemours, Inc.\u00a0(DD -1.37%)\nQ1\u00a02022 Earnings Call\nMay 03, 2022, 8:00 a.m. ET\n\nOperator\n\nGood morning, and welcome to the DuPont first quarter 2022 earnings conference call. [Operator instructions] Thank you. Chris Mecray, you may begin your conference.\n\nChris Mecray -- Vice President, Investor Relations\n\nGood morning, everyone. Thank you for joining us for a review of DuPont's first quarter 2022 financial results. Joining me today are Ed Breen, chief executive officer; and Lori Koch, chief financial officer. We prepared slides to supplement our comments during this review, which are posted on the Investor Relations section of DuPont's website and through the webcast link.\n\nPlease read the forward-looking statement disclaimer contained in the slides. During this financial review, we'll make forward-looking statements regarding our expectations or predictions about the future. Because these statements are based on current assumptions and factors that involve risks and uncertainties, our actual performance and results may differ materially from our forward-looking statements. Our 2021 Form 10-K as updated by current and periodic reports includes a detailed discussion of principal risks and uncertainties, which may cause differences.\n\nUnless otherwise specified, all historical financial measures presented today exclude significant items. We'll also refer to other non-GAAP measures. A reconciliation to the most directly comparable GAAP financial measure is included in our press release and posted to the Investor page of our website. I'll now turn the call over to Ed.\n\nEd Breen -- Chief Executive Officer\n\nGood morning, and thank you for joining our first quarter financial review. We posted strong results this quarter. But before we discuss that, I would like to thank each of our employees for their continued dedication and strong commitment to our customers. Their perseverance in the face of many obstacles is what made our results possible.\n\nI'd especially like to express our appreciation for our China-based colleagues, many of whom have endured weeks of lockdowns, but have continued to operate and get necessary work on. Also, our hearts go out to those affected by the war in Ukraine, and we sincerely hope this conflict can be ended as soon as possible. Our first quarter results from continuing operations included a strong 9% organic sales increase from the prior year or 14% growth, including the layered acquisition contribution. Organic volume increased 3%, led by an 8% increase in the E&I segment.\n\nOverall customer demand remains strong across the vast majority of end markets, led by low double-digit volume growth in both semiconductor and industrial technologies with the E&I segment and mid-single-digit volume growth in water and shelter solutions within the water and protection business. Our top-line growth included 6% average pricing increases that we took to offset the continued cost inflation that we are experiencing. We realized price increases in all businesses totaling about $190 million and a fully offset raw material, logistics, and energy cost deflation. I continue to be impressed by the job our teams are doing as we remain -- target to remain price cost neutral for the full year 2022, including the incremental actions taken in March, largely in reaction to the conflict-driven spike in energy and related costs during the period.\n\nTurning to Slide 4, I'd like to update you on key focus areas for 2022 stakeholder value creation, including our portfolio transformation, our balanced approach to capital allocation and our continued focus on growth execution. First, we believe we are on track with what we noted previously regarding the timing associated with the M&M divestiture to Celanese. The M&M transaction is anticipated to be complete around the end of the year, and we are also continuing with the process to divest the Delrin business. For the Rogers acquisition, progress is being made on the required regulatory reviews while we remain optimistic by closing by the end of the second quarter.\n\nThe process could extend into early third quarter. We continue to see no issue that would prevent a close of this transaction. I'd like to reiterate that DuPont's financial profile -- pro forma for these transactions will firmly position the company with top quartile revenue growth, operating EBITDA margins, and low cyclicality relative to top tier multi-industrial companies. Greater focus on secular high-growth end markets in electronics, water, industrial technologies, protection, and next-generation automotive will serve as a sound basis for our innovation-led organic growth execution.\n\nRegarding the Laird Performance Materials acquisition, we are also on track to achieve cost synergies of $63 million, somewhat ahead of initial expectations. The deal has been a success so far, including overall financial performance ahead of plan for both top and bottom-line results and early progress to achieve commercial synergies on top of the cost synergies noted. As one example, we are starting to see some nice synergies with Laird process and equipment technology, enabling more effective solutions for downstream customers, including auto OEMs as well as consumer electronics applications. Regarding future capital allocation and namely the net cash we will receive from our planned divestitures, we will continue to pursue a balanced strategy that includes prioritizing the return of excess capital to shareholders as well as strategic M&A.\n\nThis is consistent with our actions taken over the last year during which we increased our share repurchase and dividend allocation as well as completed the Laird acquisition. Once the Rogers and M&M transactions are completed, we will be poised to continue to improve our portfolio and financial position as well as accelerate capital return options. Given the magnitude of the anticipated deal proceeds, we expect that there will be room to execute substantial incremental share buybacks while disciplined M&A will also remain a key deployment priority. Regarding our existing $1 billion share repurchase program authorized during Q1, we anticipate completing that authorization during 2022, ahead of the one-year duration initially guided.\n\nTurning to core growth, we continue to focus on execution of our innovation-based organic growth opportunities. We are pleased with 3% volume growth in the quarter given production constraints due to lack of raw material availability and supply chain challenges. We are excited about visible growth drivers enabled by our technical innovation teams and application engineers who are squarely focused on helping customers solve their most complex challenges. In E&I, continued top line growth momentum this year is being driven by growth in semiconductor, healthcare, and displays end markets by cyclical recovery in aerospace markets and by new share gains and innovation wins muted somewhat in auto by supply chain constraints.\n\nKey examples of recent new product successes driving growth and strong margin performance include newly launched mechanical planarization pads for semiconductor manufacturing as well as new lithographic photoresist for the high-performance computing market. In W&P, we expect growth in 2022 coming from each of the lines of business. Safety has seen market growth across major segments including aerospace, electrical infrastructure, oil and gas, and healthcare, but muted by lower demand for protective garments. Shelter continues to experience growth opportunities from strong construction and remodeling trends.\n\nWater is experiencing strong mid-to high single-digit growth globally across all technologies. Examples of new innovation drivers for this segment include several new membrane product families within water to drive growth in desalination and wastewater markets as well as the launch of a new building insulation product offering increased sustainability solutions for customers. We also have a strong adhesive business that is positioned well to capture growth with its product offerings in next-generation auto and electric vehicles, especially through the commercial synergy opportunities that we expect through the Rogers acquisition. With that, let me turn it to Lori to discuss the details of the quarter as well as our financial outlook.\n\nLori Koch -- Chief Financial Officer\n\nThanks, Ed, and good morning, everyone. As Ed mentioned, we saw continued strong demand during the quarter in key end markets. Global supply chain challenges and cost inflation have persisted and even intensified during the quarter due to the war in Ukraine. In response to inflation, we continued our strategic pricing actions and were able to fully offset higher costs during the quarter related to raw material, logistics, and energy.\n\nThese factors, along with our team's continued focus on execution, contributed to net sales, operating EBITDA, and adjusted EPS results well above expectations. Focusing on financial highlights on Slide 5 for the quarter. Net sales of $3.3 billion were up 9% on both an as-reported and organic basis versus the first quarter of 2021. The acquisition of Laird, partially offset by non-core divestitures, provided 2% net tailwind to net sales while currency was a 2% headwind during the quarter.\n\nOrganic sales growth included 6% pricing gains and 3% higher volume. Pricing gains reflect the actions taken to offset overall cost inflation, including the spike in energy costs that we are seeing at our site. Volume growth reflected continued strong customer demand with order patterns remaining solid, led by electronics, industrial technologies, water, and construction end markets. These factors resulted in organic sales growth during the quarter of 10% and 9% for W&P and E&I, respectively.\n\nOn a regional basis, organic sales growth was broad-based globally with W&P driving growth in North America and EMEA and E&I driving growth in Asia Pacific. From an earnings perspective, operating EBITDA of $818 million was up 2% versus the year ago period and adjusted EPS of $0.82 per share was up 19%. The increase in operating EBITDA was driven by pricing actions, volume gains, and strong earnings from the Laird acquisitions, which more than offset higher inflationary cost pressures as well as weaker product mix in W&P and the absence of a gain on asset divestiture in E&I last year. Operating EBITDA margin during the quarter was 25%, which was better than our expectations set earlier this quarter, about 160 basis points below the year-ago period, which I'll explain further.\n\nNavigating cost inflation was a key focus during the quarter, and our success in doing so was a significant driver in our results. While the majority of the raw material inflation that we have discussed in the past related to the M&M businesses, which are now part of discontinued operations, our Remainco businesses also have inflation exposure, and we saw a spike in energy costs during the quarter, most notably in W&P. We fully offset about $190 million of cost inflation during the quarter, which kept our results whole on a dollars basis. While these pricing actions enabled us to maintain a neutral earnings profile, price cost dynamics resulted in 150 basis point headwind to operating EBITDA margin during the quarter.\n\nOur underlying operating EBITDA margin adjusted to exclude price cost factors was 26.5% or essentially flat compared to the year-ago period. Further, as you adjust margins in the prior period to exclude the onetime gain related to the asset sale in E&I, our underlying margin of 26.5% would have increased about 70 basis points from last year. Another key metric that we track is incremental margins. On a reported basis, incremental margin for the quarter was 6% from the year-ago period.\n\nHowever, I indicated previously the importance of evaluating our results on an underlying basis. If you remove the impact of price cost, incremental margin was over 20%, and if you also exclude the headwind from the onetime asset sales. On top of that, incremental margin was almost 60%. I mentioned these data points to illustrate the volume strength we are seeing within the portfolio.\n\nFrom a cash perspective, cash flow from operations during the quarter of $209 million and capital expenditures of $251 million resulted in a free cash outflow of $42 million. The cash outflow was the result of variable compensation payments to our employees, which were approximately $100 million more this year than our normal payout, and higher working capital trade includes set of actions taken to increase inventory in reaction to continued product supply constraints. We expect significant improvement in free cash flow as we move toward the second half of the year consistent with our typical seasonal pattern. Turning to Slide 6.\n\nAdjusted EPS of $0.82 per share was up 19%, compared to $0.69 per share in the year-ago period. Higher volumes and strong results from Laird collectively provided a benefit to adjusted EPS in the quarter of $0.11 per share. These gains more than offset other previously disclosed portfolio-related actions, weaker product mix in W&P, and additional tax Kapton start-up costs in E&I totaling $0.09 per share in the aggregate. A lower share count and reduced interest expense from deleveraging actions continue to benefit our EPS results.\n\nOur base tax rate for the quarter was 21.8%, and we continue to expect our base tax rate for the full year 2022 to be in the range of 21% to 23%. Turning to segment results, beginning with E&I on Slide 7. E&I delivered net sales growth of 18%, including 9% organic growth and 11% portfolio benefit from Laird, and a 2% headwind from currency. Organic growth for E&I includes an 8% increase in volume and a 1% increase in price.\n\nFor a line of business view, organic sales growth was led by semiconductor technologies, which increased mid-teens as robust demand continued, led by the ongoing transition to more advanced nodes, growth in high-performance computing and 5G communications as well as share gains. Within Industrial Solutions, organic sales growth was up low double digits on a continuation of strong volume growth led by OLED materials for new phone and television launches, ongoing strength for Kalrez product offerings, most notably for semi capex, and strong demand for healthcare applications such as biopharma and tubing. Interconnect Solutions sales decreased low single digits on an organic basis, due to a slight volume decline. Volume gains for films and laminates in certain industrial end markets were more than offset by declines in consumer electronics, primarily related to China as well as the anticipated return to more normal seasonal order patterns for smartphones.\n\nFor the full year, we expect Interconnect Solutions to be up mid-single digits on an organic basis, led by strong demand in the second half and additional capacity coming online later this year from our Kapton expansion. From a regional perspective, E&I delivered sales growth in all regions with high single-digit organic growth in Asia Pacific, noting China was down slightly. Operating EBITDA for E&I of $476 million increased 9% as volume gains, strong earnings from Laird, and pricing actions more than offset the absence of a prior-year asset sale gain, higher raw material and logistics costs, and a continuation of start-up costs associated with our Kapton capacity expansion. Operating EBITDA margin of 31% reflects sequential improvement from the fourth quarter of more than 200 basis points.\n\nOn a year-over-year basis, the primary driver of the decline in operating EBITDA margin was the absence of a prior-year gain. Adjusting margins in the prior year to exclude the onetime benefit, operating EBITDA margin was down 70 basis points year over year as a result of price cost and Kapton start-up costs more than offsetting volume gains. Turning to Slide 8, W&P delivered net sales growth of 8%, consisting of 10% organic growth and a 2% headwind from currency. Organic growth for W&P reflects broad-based pricing actions across the segment implemented to offset cost inflation.\n\nVolumes were flat as gains in shelter and water solutions were offset by declines in safety. From a line of business view, organic sales growth was led by shelter solutions, which was up high teens driven by pricing actions and continued robust demand in North American residential construction for products such as Tyvek, Kalrez as well as ongoing improvement in commercial construction for quarry and surface products. Sales for water solutions were up high single digits on an organic basis on volume and pricing gains. Global demand remains strong for all water technologies and across all regions.\n\nWithin Safety Solutions, sales were up mid-single digits on an organic basis as pricing actions were partially offset by lower volumes of Tyvek as we shifted production from garments to other end-market applications. Volumes were up slightly for aramid fibers on continued improvement in industrial end markets. Operating EBITDA for W&P of $341 million declined 4% versus last year due to a weaker product mix. Operating EBITDA margin was better than our expectations set earlier in the quarter, but the impact of price cost was about a 210 basis point headwind to margin.\n\nExcluding the price cost impacts, operating EBITDA margin was about 26%, approaching more normalized levels for W&P. Before I turn it back over to Ed, I'll close with a few comments on our financial outlook on Slide 9. Despite the strong start to the year and solid demand, the macro environment remains volatile with several key and certain factors. Based on our expectations and in consideration of these uncertainties, our full year guidance ranges for operating EBITDA and adjusted EPS remain unchanged at $3.25 billion to $3.45 billion and $3.20 to $3.50 per share, respectively.\n\nThese ranges include a $35 million earnings headwind as a result of suspending operations in Russia. We are increasing our guidance range for net sales to be between $13.3 billion and $13.7 billion to reflect price increases needed to offset cost inflation, which we now anticipate at $600 million in year-over-year headwinds. Although underlying demand in key end markets such as electronics, industrial technologies, and water remains strong, we are seeing further supply chain constraints, primarily from additional government-mandated lockdowns in China, which will likely impact volume growth in the second quarter. Based on these anticipated headwinds as well as an element of previously projected Q2 sales realized in the first quarter, we expect second quarter 2022 sales to be between $3.2 billion and $3.3 billion, or up about 5% year over year at the midpoint.\n\nBased on these same assumptions, we expect second quarter operating EBITDA between $750 million and $800 million, and adjusted EPS decrease $0.70 and $0.80 per share. At the midpoint of our guidance, second quarter operating EBITDA margin is expected to decline just over 100 basis points sequentially as supply chain constraints are assumed to impact production rates. We expect operating EBITDA margin in the back half of 2022 to improve on typical seasonal volume strength and improved plant utilization as we clear COVID-related production challenges impacting the first half of the year. This outlook assumes moderating China lockdown impacts as we get into mid-May, given the positive trajectory in the Shanghai region and our limited exposure around Beijing.\n\nHowever, further outlook risks could be triggered as the lockdown spreads to Shenzhen and the Pearl River Delta region, given the concentration of manufacturing and shipping there for DuPont as well as our suppliers. With that, let me turn the call back to Ed.\n\nEd Breen -- Chief Executive Officer\n\nBefore we take your questions, I'd like to highlight that we published our annual sustainability report this week, and I'm really proud of the progress we made on our 2030 goals. Our sustainability strategy is grounded in three pillars: innovation, protecting people and the planet, and empowering employees and customers. I'll just note a few highlights. DuPont is leveraging our innovation focus to help customers meet their sustainability goals.\n\nA great example of that is the new formulations within our building installation products that helped increase energy efficiency as well as new technologies from our water solutions business that reduced process energy intensity. We're also focusing on renewable energy as part of our integrated climate and energy approach. Last year, we signed a virtual power purchase agreement that will supply about 25% of DuPont's total electricity starting in 2023. Additionally, Apple just announced that DuPont was selected to join their supplier clean energy program.\n\nwhich is an example of DuPont working with industry partners to drive sustainability progress at scale. We continue to advance our commitments to DE&I. We are excited about the newest female nominee to our board of directors, Christina Johnson. Also, the strong gender and ethnic representation of our leadership teams continue despite competitive labor markets.\n\nThere are many great examples and stories in the report of how our teams are delivering on our purpose and driving sustainability. Overall, our teams have done a tremendous job. With that, we are pleased to take your questions. And let me turn it back to the operator to open the Q&A.\n\nOperator\n\n[Operator instructions] Your first question comes from Steve Tusa from J.P. Morgan. Please go ahead.\n\nSam Yellen -- J.P. Morgan -- Analyst\n\nHey, guys. This is actually Sam Yellen on for Steve. Thanks for taking my question.\n\nEd Breen -- Chief Executive Officer\n\nSure.\n\nSam Yellen -- J.P. Morgan -- Analyst\n\nCan you talk about the sequential trends from 2Q to 2H? It looks like a big step up in EBITDA. Is that the China recovery or something else? And as part of that, maybe give us an update on the price cost spread on a quarterly basis? What are you expecting in 2Q and then in 2H when comparing to the neutral you did in Q1? And then is there anything else we're missing? Thank you.\n\nLori Koch -- Chief Financial Officer\n\nNo. Thanks, Ashley. The second half ramp from the first half is really just a reflection of our seasonal volume improvement in the back half. Within E&I, it's primarily driven by smartphones as we go into the Christmas season and, within water, a lot in the construction space as we see a ramp there.\n\nSo the list on volume is dropping to the bottom line, which is translating to the EBIT improvement and the margin improvement in the second half as we drive leverage through the P&L. On your question around net price, so we'll expect all year to remain neutral on net price cost that we raised the midpoint of the guidance for the full year to reflect about another $100 million of raw material escalation on a full year basis. So we're now expecting somewhere in the range of $600 million that will fully offset with price. So that won't change coming out of the first quarter for the rest of the year.\n\nEd Breen -- Chief Executive Officer\n\nAshley, I would just add to Lori's point, the first half to second half ramp, it is our typical seasonality. If you go back and look at last year, it's about a 7% sequential lift first half, second half, and that's typically what we do because of the items that Lori mentioned. So nothing unusual in the pattern there.\n\nSam Yellen -- J.P. Morgan -- Analyst\n\nGot it. Thank you.\n\nEd Breen -- Chief Executive Officer\n\nThank you.\n\nOperator\n\nYour next question comes from Scott Davis from Melius Research. Please go ahead.\n\nScott Davis -- Melius Research -- Analyst\n\nHey. Good morning, everyone.\n\nEd Breen -- Chief Executive Officer\n\nGood morning, Scott.\n\nScott Davis -- Melius Research -- Analyst\n\nLori and Chris, welcome. Welcome aboard, Chris. Anyway, the -- is there something -- can we talk in terms of like backlog or book-to-bill? Did backlog actually grow in the quarter? I mean, or any metric, I guess, you can give us -- to give us a sense of top-line pent-up demand?\n\nEd Breen -- Chief Executive Officer\n\nYes, Scott. The backlog looks great. It's been staying at very elevated levels. We look at it weekly.\n\nThere's really no end market that's not feeling good. As you know, auto is down a little just because of auto production, but that's not a demand-driven thing. It's just chip shortages and supply chain issues. But all our end markets from an order pattern standpoint feel good as of looking at it this week.\n\nSo no issues there at all. And really, the only issues we're dealing with here, again, it's not demand driven. It's really more centered around supply chain and China and COVID lockdowns for the guide on the second quarter. But if we didn't have those issues, our sales would definitely be higher in the second quarter, but that's what we're dealing with there.\n\nScott Davis -- Melius Research -- Analyst\n\nYes. It makes sense. And is price -- as we speak kind of now, is price still going up because inflation is still going up? Or are we at a point now where we've kind of hit some sort of plateau?\n\nEd Breen -- Chief Executive Officer\n\nIt seems like we've plateaued, Scott. We -- all the price increases are implemented. When the war broke out, we did a whole another round of price increases, mainly because the natural gas lifting is significantly as it did. And by the way, other constraints in there, but that was the big one.\n\nSo we did a round of increases again, which we had just finished doing. We did it again in every business. And as we said, we caught all the inflation in the quarter by important roles on logistics and on energy. So we caught everything with $190 million of inflation that we saw.\n\nAnd as Lori just mentioned a minute ago, we think it's plateaued. If it hasn't, we'll do another round of price increases. I feel like we can get it if we have to, but it does appear to have plateaued. So we'll have an incremental $600 million of inflation if things hold where they're at for this year, and we'll have that all covered with price.\n\nScott Davis -- Melius Research -- Analyst\n\nOK. Sounds great. Good luck. Thanks.\n\nAppreciate it.\n\nEd Breen -- Chief Executive Officer\n\nThanks, Scott.\n\nOperator\n\nYour next question comes from Jeff Sprague from Vertical Research. Please go ahead.\n\nJeff Sprague -- Vertical Research Partners -- Analyst\n\nThank you. Good morning, everyone.\n\nEd Breen -- Chief Executive Officer\n\nHey, Jeff. Good morning.\n\nJeff Sprague -- Vertical Research Partners -- Analyst\n\nGood morning. Ed, on share repurchase -- excuse me, battling a little cold here. Hopefully, it's not COVID. Your language on share repurchase went from it being important last quarter to substantial incremental share repurchase.\n\nSo I sense a bit of a pivot there in your posture. Maybe you could just elaborate a little bit more. And do you need to wait for the M&M proceeds to actually do more? Or can you get a bit of a running start on maybe the incremental that you're talking about?\n\nEd Breen -- Chief Executive Officer\n\nYes. So Jeff, I think summarized it well. We're leaning much more toward a decent large, if you could call it, share repurchase with where our multiples at. I don't think this is where DuPont's model will be sitting in the future and obviously softness in everyone's stock price just because of recent external events out there.\n\nSo we're going to step on the $1 billion share repurchase a little bit quicker as we said in our prepared remarks by a quarter or four months, something like that, and get it done early. And I would expect conversations with the board that we're going to look at a much larger share repurchase program. I don't think we need to wait until the proceeds are necessarily in, but I would like to make sure nothing else crazy is going on in the world. We do have a $5.2 billion outstanding loan on the Rogers piece that will get paid off.\n\nSo our leverage will be north of three. And with that, but when we get the proceeds from M&M, you kind of know the math. We're sitting on lots of billions of dollars here. So yes, you do secure a little bit of shift in tone because of where the multiples at.\n\nThe market is a little bit tough right now for everybody, and my gut is we're going to step on it in a bigger way.\n\nJeff Sprague -- Vertical Research Partners -- Analyst\n\nThat's great to hear. And then also, could you just -- maybe this is for Lori, just how significant on the top line was China, kind of the lockdowns and supply chain and COVID issues? And how big a part of kind of the Q2 outlook is it?\n\nLori Koch -- Chief Financial Officer\n\nYes. In total, there's two major pieces that are impacting the 2Q guidance, so -- and they're both related to China. So first is a shift of sales that we had expected to land in 2Q that landed in 1Q, and that was primarily with our customers pulling in on volume because of what was going on in China. We would size that at about $3 million to $5 million of sales.\n\nAnd then as far as the shutdown that happened, it started to get progressively worse in mid-March, and we're anticipating a mid-May reopening. We estimate that we missed about $20 million worth of sales.b And there's also an impact on our margins with our plants not running at full capacity. So we have two sites in China that went into full lockdown mode in mid-March. We expect them to be fully reopened by mid-May.\n\nAnd then we had some key raw materials within our electronics business that we source from China that we weren't able to get full supply, so we ran some of our domestic plants at lower unit rates. And so that was impacting our margin profile in the second quarter as well.\n\nEd Breen -- Chief Executive Officer\n\nYeah. To give you a specific on what Lori said, in Circleville, Ohio, we make our Kapton, which is a high-margin product. We're fully sold out. We get half of a monomer that we need out of China, and we had delayed shipments out of China.\n\nSo we did have supply at the monomer. So instead of shutting -- running it full tilt and then shutting the facility down, we just eased off the run rate some. We know when we're now getting supply from China. So there's an example.\n\nIt kind of hits your rates for one month, month and a half, like that. So it's just these one-offs because of the China lockdowns, which hopefully it dissipate as we exit the quarter.\n\nLori Koch -- Chief Financial Officer\n\nAnd I think the other piece, Jeff, too, with our guidance for the second quarter, but it's beyond just China and then the production-related effects with Russia. So we noted in our slides that we pulled Russia out. On a full year basis, it's about $35 million of EBITDA, probably about $80 million of sales that's impacting primarily 2Q and beyond.\n\nEd Breen -- Chief Executive Officer\n\nAnd then, Jeff, when you look at the full year guide, we beat by $90 million on EBIT in the first quarter kind of from consensus. We're down kind of $60 million in the second quarter off of, I'll use you guys, consensus, all because of what Lori just described here. But then we have nothing in the second half that's unusual. It's our normal seasonal ramp.\n\nThat's 7% that I mentioned. That's what we're counting on, including we'll get some better unit rates from the things we just described to you. So no real big change in order patterns for us that we would typically see.\n\nJeff Sprague -- Vertical Research Partners -- Analyst\n\nGreat. Thanks for that color. Appreciate it.\n\nOperator\n\nYour next question comes from John Walsh from Credit Suisse. Please go ahead.\n\nJohn Walsh -- Credit Suisse -- Analyst\n\nHi. Good morning and thanks for taking the questions here.\n\nEd Breen -- Chief Executive Officer\n\nGood morning, John.\n\nJohn Walsh -- Credit Suisse -- Analyst\n\nI guess just, first, thinking about a couple of end markets that you touch, where there's some investor angst, I mean, residential, auto, consumer smartphones. Can you talk about what you're kind of expecting there from volume? And then what you're expecting from price either if you can break it out, what's inflation? And then that price component that you have because of the higher value you're adding to the customers offering there?\n\nLori Koch -- Chief Financial Officer\n\nYes. I would say as far as demand is concerned in the three end markets, you had noted, we saw strength in residential construction. We expect that to continue to be a point of strength in the second quarter. We did note softness in consumer electronics, but that was primarily in China with respect to the lockdown and also a little bit of an impact of our own viewing of seasonality with respect to when we do our normal smartphone shipments.\n\nSo we've telegraphed in the past that the first half will be weaker, the second half will be stronger because of a change in seasonal patterns as we sell into the smartphone market. But on a full year basis, we expect that end market to be up mid-single digits. And then in auto, you've seen the revisions downward with respect to IHS auto builds. I think now it's sitting at 4% on a full year basis.\n\nSo our estimates would probably be a little bit lighter than that with respect to what we think that the market will do. But the underlying demand remains strong. It's just really a matter of supply chain specifically around the chip constraints that are impacting that. But I think the highlight to you there is we do continue to see very strong growth within the EV space.\n\nAnd so for us, a large portion of that comes from our adhesives business. We saw a really nice growth in our EV-related sales in Q1, and we expect to about double those sales in Q2 in line with where the EV market is going in general. And we really look forward to the incoming business from Rogers to pair with our business to really take advantage of the opportunity there. On the price side, I wouldn't say it materially different across those end markets.\n\nIt's what we're seeing with respect to inflation by segment. So within E&I, the inflation is not as material as what it is within W&P, and you see that in price. So we got about 1% in E&I in price and about 10% in W&P. So there is a difference there, but nothing more than just around the raw material inflation-related items.\n\nJohn Walsh -- Credit Suisse -- Analyst\n\nGreat. Thank you. And then maybe one quick follow-up to Jeff's question around capital allocation. Maybe can you just update us on what the deal pipeline looks like and if you're seeing sellers expectations change given what's happened in the public markets? Thank you.\n\nEd Breen -- Chief Executive Officer\n\nYes. So my gut is as we sit right now, I don't see any deal that we would want to do until we're in this 2023. And I'm not saying I know something is available in 2023. But the way stock prices are moving around right now and all, it just makes it a tougher environment.\n\nSo I don't see anything happening until we get into 2023. And quite frankly, we don't have anything -- we have things we're -- a couple of things we're interested in, as I said before, but I don't see them actionable anytime in the near future. So that could change, so don't hold me to that. But I can't see anything happening until we're nicely into 2023, if then depending on what's going on.\n\nJohn Walsh -- Credit Suisse -- Analyst\n\nGreat. Appreciate it. Thanks for taking the questions.\n\nEd Breen -- Chief Executive Officer\n\nYep.\n\nOperator\n\nYour next question comes from Chris Parkinson from Mizuho. Please go ahead.\n\nChris Parkinson -- Mizuho Securities -- Analyst\n\nGreat. Thank you so much. There are a lot of moving parts to the DuPont capital allocation thesis, just including the net proceeds from deals, base free cash flow generation, working capital, and then, obviously, your stated buyback goals. When it's all said and done, and I appreciate your remarks for the deal outlook for 2023, just absent anything new in 2022, what is the kind of the base range that you -- based on the current buyback that you believe you'll have cash on the balance sheet, just plus or minus? Thank you.\n\nLori Koch -- Chief Financial Officer\n\nSo are you talking after considering the proceeds from the M&M sales?\n\nChris Parkinson -- Mizuho Securities -- Analyst\n\nYeah.\n\nLori Koch -- Chief Financial Officer\n\nSo yeah, if you look at the proceeds from the M&M sales, the cash flow generation in 2022 and 2023 as well as where our leverage targets are at 2.75 times, probably where we would expect to be, you quickly get to the $10 billion to $11 billion range of cash to deploy after we pay down the Rogers debt. So as we have mentioned on the call, it's significant. And we'll look to take a balanced approach to driving significant share repurchase as well as M&A opportunities.\n\nChris Parkinson -- Mizuho Securities -- Analyst\n\nGot it. And the second question I have, just obviously, over the last couple of weeks, there's been a bit of noise across global electronics, some of your peers, which has been pertinent to semis, 5G, base consumer electronics demand. A lot of that driving from China. But just can you just give us a quick update overall about how your team is thinking about your relative subsegments within E&I, just given the current demand environment? And then also how you would project your relative performance versus some of your core U.S.\n\npeers. Thank you.\n\nLori Koch -- Chief Financial Officer\n\nYes. So we see very strong demand continuing in electronics, and so we had very strong results in Q1. On a full year basis, we expect to be up pushing double digits within electronics between price and volume, and we'll obviously add to that as we close the Rogers transaction later this year. So we see a lot of strength, we see a lot of opportunity.\n\nIf you look at -- we do a lot of detailed analysis about our results versus peers. And a couple of them have already been out before us, and we back up very nicely when you compare like-to-like product lines. And so we also stack up very nicely when you compare our results versus some of the key benchmarks out there. So for example, MSI is one of the key components of the semi business.\n\nPeople are expecting that to be up 7% to 8%. We've mentioned that we should outperform by 200 to 300 basis points. And if you look at our Q1 results in semi, we were in line with that expectation. So we are very excited about the portfolio.\n\nWe'll look to continue to see where we can opportunistically broaden and strengthen that portfolio as well.\n\nChris Parkinson -- Mizuho Securities -- Analyst\n\nThank you, as always.\n\nOperator\n\nYour next question comes from Steve Byrne from Bank of America. Please go ahead.\n\nSteve Byrne -- Bank of America Merrill Lynch -- Analyst\n\nYes. Thank you. Are there any water-treating technologies that are really deficient in your platforms? Would you consider acquiring or developing anything you don't have and maybe more broadly in water? Would you consider moving downstream to essentially utilize your expertise in the breadth of water-treating technologies you have to provide service to customers as a downstream expansion similar to Ecolab?\n\nEd Breen -- Chief Executive Officer\n\nYes. I would say two things, Steve. Our portfolio, we feel very good about. And it's a fairly broad portfolio, so we touch most of the water filtration type markets out there, wastewater home, home applications, which are big for us in China, desalination, as we mentioned in our prepared remarks.\n\nSo we feel good about the breadth of what we have in the technology we have behind it, and we continue to bring new products out to market. The one area that we would look at, and by that it doesn't mean it's an acquisition, it could be organically done as we need to expand our manufacturing footprint and we need a bigger presence with the manufacturing in the Asia market, which is a very fast-growing market for us. So we've been studying very hard, a project there to bring up a facility in the next couple of years in that area. So that's a high priority for us.\n\nAnd then this kind of goes to the second part of your question there. The one opportunity we have or potentially have in our R&D teams and application teams are looking at is digitizing the water business. So we know when replacement components are needed ahead of time, and it's kind of systematized, and that could be a real opportunity for us to kind of satisfy our customers by doing it that way. And that opportunity, we've been studying hard for the last year.\n\nSteve Byrne -- Bank of America Merrill Lynch -- Analyst\n\nMaybe any update from you on PFAS issues? Anything -- any trends that you're observing? Any changes to inbound inquiries that you can comment on?\n\nEd Breen -- Chief Executive Officer\n\nYes. Nothing new has changed on the landscape except, I'll just say, we continue to be in conversations with the plaintiffs down in the MDL. I feel like we will make progress this year on that. By the way, the judge has continued to encourage us, the judge down there in charge of these MDL cases has actually encouraged us and the plaintiffs we talk in and coming up with a settlement.\n\nAnd so I'll just leave it at that for now, but nothing new besides that.\n\nSteve Byrne -- Bank of America Merrill Lynch -- Analyst\n\nThank you.\n\nEd Breen -- Chief Executive Officer\n\nYep.\n\nOperator\n\nYour next question comes from David Begleiter from Deutsche Bank. Please go ahead.\n\nDavid Begleiter -- Deutsche Bank -- Analyst\n\nGood morning. Ed, how is Rogers EBITDA tracking your earlier expectations given what you've seen in both Q1 and Q4? I believe the EBITDA view was $270 million for this year.\n\nLori Koch -- Chief Financial Officer\n\nYes. So in the first quarter, they were under the impact of the same things that we were with respect to the China COVID situation. We're really looking forward to the second half when we will own them, and they have a pretty sizable expected ramp as those end markets really open up coming out of the China recovery, and they continue to see a nice growth opportunity within the EV space. And so I think if you look at the second half trajectory, that's being planned by Rogers, it would be more in line with where our expectations were on a full year basis for that portfolio.\n\nEd Breen -- Chief Executive Officer\n\nThey have the backlog. A lot of it is in the EV space. We've looked at it. So it's just a matter of, A, getting over the lockdown issue in China and then actually accomplishing the ramp in their production rates.\n\nBut we think second half of the year, they'll be right around the ZIP code of where we would expect it.\n\nDavid Begleiter -- Deutsche Bank -- Analyst\n\nGreat. And Lori, can you comment on what was M&M EBITDA in the quarter?\n\nLori Koch -- Chief Financial Officer\n\nYes. So that will come out Friday in the Q. So in the Q, we'll deconstruct the discontinued operation summary that we've reported today. I can give you a high level that they were impacted, obviously, by the China COVID situation as well and the auto end markets obviously being the largest factor, but they did continue to do a really nice job of getting priced.\n\nDavid Begleiter -- Deutsche Bank -- Analyst\n\nGreat. Thank you very much.\n\nEd Breen -- Chief Executive Officer\n\nThank you, David.\n\nOperator\n\nYour next question comes from Aleksey Yefremov from KeyBanc Capital Markets. Please go ahead.\n\nAleksey Yefremov -- KeyBanc Capital Markets -- Analyst\n\nThank you. Good morning, everyone. Can you update us on the -- how the Delrin sale process is going?\n\nEd Breen -- Chief Executive Officer\n\nYes. So Delrin, by the way, we've been putting the data room together and all that. We're just getting ready to launch on that, and we would expect that Delrin will take about a year, just like the other part of M&M to actually close the deal. So we'll get a deal done in a four-, five-month window and then regulatory approvals that will kind of take like a year.\n\nSo data room is getting finished up. And obviously, we've had inbound phone calls about it, but we haven't really going into deep engagement, yet. We're just getting ready to do that kind of in the next couple of weeks.\n\nAleksey Yefremov -- KeyBanc Capital Markets -- Analyst\n\nAnd Ed, you provided initially some expectations for valuation during the sale of mobility business, would you care to do the same about Delrin may be in broad terms? What are your expectations for the multiple?\n\nEd Breen -- Chief Executive Officer\n\nNo. I am not going to do that. We sold 90% of it at 14.1 times. So I think what we said more than happened, and I will say Delrin is a very good business.\n\nIt's a very high EBITDA business, so we're looking forward to a nice sale there.\n\nAleksey Yefremov -- KeyBanc Capital Markets -- Analyst\n\nFair enough. Thanks a lot.\n\nEd Breen -- Chief Executive Officer\n\nThank you.\n\nOperator\n\nYour next question comes from John Spector from UBS. Please go ahead.\n\nJosh Spector -- UBS -- Analyst\n\nHi. This is Josh Spector. So just a question on WMP and pricing and margins, particularly, I think in the past that segment, margins have been mid-to-upper 20%. Now you're kind of more low to mid-20%.\n\nVery clear that you're getting pricing to offset inflation. But do you have any visibility to get pricing more than inflation over the next 18 months, two years? Should we expect margins to expand in the outlook over time? Thanks.\n\nLori Koch -- Chief Financial Officer\n\nYes. So the underlying margin as we look at it, excluding pricing cost was close to 26% in the quarter, as we noted on the call. So starting to get back to the more normalized margins that we would expect for the segment in the upper 20s. So -- and in normal times to outside the inflation, we would expect to get 1% to 2% of price out of that portfolio that does drop to the bottom line with respect to new product innovations and favorable mix as we move into the more higher-margin segment.\n\nSo we'll continue to see headwinds on as-reported margins as we go after the year just because of price costs, and we'll continue to let you know what that adjustment looks like, so you can get to more of an underlying margin basis opportunity for the WMP segment.\n\nJosh Spector -- UBS -- Analyst\n\nOK. But I guess we could take that to mean that this -- if inflation stays where it is and your pricing toward that, this becomes more of the new normal and then its normal incremental margins. You're not expecting accelerated pricing to persist to drive margins back up in this segment over time. That's not your expectation.\n\nEd Breen -- Chief Executive Officer\n\nNo. I think what would occur is hopefully commodity prices come down, and we hold obviously some of the price because of the products that we have. I would think that's the more rational way things could play out here. And you're not incorrect.\n\nThis business can run at like 28% EBITDA margin. So we're certainly not pleased at 26%, but 26%, we don't feel bad about in this environment, but we would certainly strive to be more in that 28% range, and we have been there before. So as Lori said, part of it, you'll just get by. If you just take all of this price cost out for a second because it's not normal times, we'll get a couple of points in pricing every year with our new product introductions.\n\nWe don't get paid like you do in electronics, and we truly can get incremental net pricing in the business, which will help. But our biggest opportunity, as we've highlighted in the past, is continue to get capacity released from these bigger assets like Tyvek and Nomex. We have a lot of programs around that. And that will drive the throughput through those facilities, which really has an impact on the numbers.\n\nSo we do think this business should run a couple of hundred basis points higher, and we'll get there.\n\nJosh Spector -- UBS -- Analyst\n\nOK. Thank you.\n\nEd Breen -- Chief Executive Officer\n\nYep. Thank you.\n\nOperator\n\nYour next question comes from Vincent Andrews from Morgan Stanley. Please go ahead.\n\nVincent Andrews -- Morgan Stanley -- Analyst\n\nThank you and good morning, everyone. If I can just ask, in Safety Solutions, where you are sort of on, I guess, what would be considered hard COVID comps with Tyvek into healthcare, and was that part of what was driving sort of the weaker product mix in the overall segment?\n\nLori Koch -- Chief Financial Officer\n\nYes, that was it. So it was a function of -- last year, we were producing full-on Tyvek garments. And so we were limiting changeovers on the lines, just given that we weren't making other end markets like medical and other types of end market uses for Tyvek. And so as you now go into a more normalized environment, you have more changeovers.\n\nSo, therefore, your production is a little bit less, and that was what was driving the impact of the weaker mix within the W&P segment.\n\nVincent Andrews -- Morgan Stanley -- Analyst\n\nOK. And just as a follow-up, Lori, and maybe this will make more sense, it would be easier to follow once we have the Q. But just looking at sort of what corporate did on an EBITDA basis in the quarter versus if I look at Slide 14 and you got corporate expense of $135 million, stranded cost of $50 million, which would total up to $185 million, and then you've got unquantified results of retained businesses in biomaterials. So can you give us a little bit of a help on sort of how this is going to progress over the year? Presumably, you start making progress on those stranded costs, the corporate, we can kind of run rate, but what about that third piece of the retained businesses in biomaterials?\n\nLori Koch -- Chief Financial Officer\n\nYes. So there are three buckets, as you had mentioned. And so the retained pieces, the margins, I would say, are in the mid once you get on an upward trajectory as we get outside of the COVID lockdown. So the largest piece of the retained business is the adhesives business, and it did see an impact in the quarter with respect to the China situation.\n\nSo that's the biggest season. And we will disclose the revenue of the retained businesses in the Q on Friday. When you get back, you'll be able to calculate kind of what the margin profile was for that space. With respect to normal corporate expenses, those will be in the range of $135 million on a full year basis as we have in our supplemental guidance.\n\nAnd so you would expect around $25 million, $26 million for the quarter. And then the third piece are the net stranded costs, and we continue to be in the range of about a net $50 million on a full year basis, and that's our target to get after as we look to eliminate those going forward.\n\nVincent Andrews -- Morgan Stanley -- Analyst\n\nThanks very much.\n\nOperator\n\nYour next question comes from Mike Sison from Wells Fargo. Please go ahead.\n\nMike Sison -- Wells Fargo Securities -- Analyst\n\nHey. Good morning. It's just, I guess, a quick follow-up on Rogers. I guess if they're being affected by China in 2Q, sequentially, EBITDA probably doesn't improve a lot.\n\nAnd then if we get on the run rate that you noted for the second half, we're probably somewhere in the low $200 million for EBITDA. And I know you don't own the business yet. But so just as a follow-up, why do you think things will improve in the second half? And then any updates on synergies that you can accelerate given -- it seems like '22 is going to come in a little bit short for Rogers this year.\n\nEd Breen -- Chief Executive Officer\n\nYes. Rogers will not run around $200 million in the second half of the year. They have -- the demand is there. We know the book, by the way, again, muted pretty significantly by COVID China.\n\nAnd don't forget, it's auto related, a lot of the business. So that's not being as hot as it should, even though end-market demand is there. But they'll be running at a much more significant rate in the third quarter, assuming, again, the COVID stuff is all cleaned up, lockdowns have ended. And we have line of sight where we're allowed to talk about synergy work on the cost side of $115 million.\n\nWe're highly confident in it on a percentage basis, with the combo of that coming in with our life business. It's not a percent that's on the high end at all. So like Laird with $60 million, we now have line of sight detail by detail to $63 million in this one. We have -- we're really racking and stack and where we have a lot of it identified.\n\nSo we'll get at it really quick. And remember, one of the things that will happen immediately on the Rogers synergies is there's corporate expense of some significance because it's a public company. And that will be cleaned up very, very quickly, and then we'll start on the rest of the synergies. So -- but it will run at a very different rate in the second half of the year.\n\nMike Sison -- Wells Fargo Securities -- Analyst\n\nRight. So for '23, we should really be thinking about 270 plus whatever growth that the industry should provide as kind of the base case for -- when we model in Rogers for '23.\n\nEd Breen -- Chief Executive Officer\n\nYeah. I think that's fair. With synergies kicking -- with then you got them kicking in. We'll hopefully move fast on that.\n\nMike Sison -- Wells Fargo Securities -- Analyst\n\nUnderstood. Thank you.\n\nEd Breen -- Chief Executive Officer\n\nThanks, Mike.\n\nOperator\n\nAnd your next question comes from Arun Viswanathan from RBC Capital Markets. Please go ahead.\n\nArun Viswanathan -- RBC Capital Markets -- Analyst\n\nGreat. Thanks for taking my question. I guess I just had a longer-term question. So several years ago, your electronics business faced a lot of pressure in China around innovation and with the some Solamet paste product.\n\nI know that's been disposed of. But do you see that kind of issues cropping up in any of your markets in the future? That would be my first question. Thanks.\n\nEd Breen -- Chief Executive Officer\n\nNo. I don't at all. There's nothing in the portfolio. Actually, not -- 95% of the portfolio is cutting-edge technology.\n\nIf you haven't had the chance, we did all the kitchens recently on the electronics business. I think we're in a very strong technology position, and we're constantly innovating. It's a fast-paced innovation in electronics, both -- we're innovating literally monthly coming out with new products in the marketplace. We're always on the cutting edge.\n\nSo I don't see that. I think what you were mentioning was Solamet based, which, yes, was more of a commoditized business that was current, but that's not where the portfolio is headed and certainly not in addition to the acquisitions with Laird and Rogers. They're very key positions we have in great technology plays.\n\nArun Viswanathan -- RBC Capital Markets -- Analyst\n\nThanks for confirming that. And then if I could, is there any update you could provide on any of the PFAS dynamics? Do you expect any kind of settlement by year-end with the water districts? Or what are you working on, on that side? Thanks.\n\nEd Breen -- Chief Executive Officer\n\nYes. No, we've been -- as we've mentioned before, we've been talking about settlement with the plaintiffs and mostly, obviously, around the water cases. And as I have mentioned a few minutes ago, the judge has even encouraged both parties to be talking to each other. I think that was made public, I don't know, a month or six weeks ago.\n\nSo hopefully, good progress this year.\n\nArun Viswanathan -- RBC Capital Markets -- Analyst\n\nThanks.\n\nEd Breen -- Chief Executive Officer\n\nThanks, Arun.\n\nOperator\n\nAnd the last question for today comes from Laurence Alexander from Jefferies. Please go ahead.\n\nLaurence Alexander -- Jefferies -- Analyst\n\nI guess a question about your degree of visibility. In terms of how customers are sharing development schedules and order books and the shift in DuPont's portfolio, how many quarters out do you feel you have good visibility at this point?\n\nLori Koch -- Chief Financial Officer\n\nYeah. I mean we do look at that to see how our order patterns are. I would say, on average, we have about 60 days visibility to orders that come in, in combination between E&I and W&P. It's a little bit longer in W&P than what it is in E&I.\n\nBut as we had mentioned earlier in the call, we look at a 20-day order pattern every week, and it has not changed in any significance for the past several months. And so we continue to see very strong underlying demand. Some of our backlog within the water space and within the adhesive space has started to build with the dynamics that we're navigating within the China COVID situation, but overall demand remains very, very strong.\n\nEd Breen -- Chief Executive Officer\n\nAnd in part, I would just give you one other angle. Obviously, we look at very hard. And you sort of, I think, just made this comment. We work very closely with our customers on design wins.\n\nBy the way, as those Laird and Rogers, it's a very key component of business. So we can see -- again, we can't see overall demand out 6 months, but we can see where trends are developing where we're going to have nice lift in business. So as Lori just mentioned, our adhesives business, we are bidding on and working from a design in on a lot of applications in the battery and the auto -- next-generation auto market. And we know where we're getting wins or we're close to getting wins.\n\nSo that's something we track very, very closely to look at those trends, same within semiconductor, same within the water business. So that's important to us to look at also.\n\nOperator\n\nI will turn the call back over to Chris Mecray for closing remarks.\n\nChris Mecray -- Vice President, Investor Relations\n\nAll right. Thanks, everybody, for joining the call. And just for your reference, a copy of the transcript will be posted on our IR website shortly. This concludes our call.\n\nThanks again.\n\nOperator\n\n[Operator signoff]\n\nDuration: 60 minutes\n\nChris Mecray -- Vice President, Investor Relations\n\nEd Breen -- Chief Executive Officer\n\nLori Koch -- Chief Financial Officer\n\nSam Yellen -- J.P. Morgan -- Analyst\n\nScott Davis -- Melius Research -- Analyst\n\nJeff Sprague -- Vertical Research Partners -- Analyst\n\nJohn Walsh -- Credit Suisse -- Analyst\n\nChris Parkinson -- Mizuho Securities -- Analyst\n\nSteve Byrne -- Bank of America Merrill Lynch -- Analyst\n\nDavid Begleiter -- Deutsche Bank -- Analyst\n\nAleksey Yefremov -- KeyBanc Capital Markets -- Analyst\n\nJosh Spector -- UBS -- Analyst\n\nVincent Andrews -- Morgan Stanley -- Analyst\n\nMike Sison -- Wells Fargo Securities -- Analyst\n\nArun Viswanathan -- RBC Capital Markets -- Analyst\n\nLaurence Alexander -- Jefferies -- Analyst\n\nMore DD analysis\n\nAll earnings call transcripts"}
{"id": "003a6557-fe89-4273-8f21-7225ed6335fe", "companyName": "KnowBe4, Inc.", "companyTicker": "KNBE", "quarter": 2, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/05/knowbe4-inc-knbe-q2-2022-earnings-call-transcript/", "content": "KnowBe4, Inc.\u00a0(KNBE 0.39%)\nQ2\u00a02022 Earnings Call\nAug 04, 2022, 8:30 a.m. ET\n\nOperator\n\nLadies and gentlemen, thank you for standing by and welcome to KnowBe4 second quarter 2022 results conference call. [Operator instructions] Now it is my pleasure to turn the call over to Ken Talanian, KnowBe4's senior vice president of FP&A and investor relations.\n\nKen Talanian -- Vice President of Investor Relations\n\nAs a reminder, our commentary today will include non-GAAP financial measures. Information regarding our non-GAAP financial results, their limitations, and reconciliations of our GAAP and non-GAAP results can be found in our earnings release, which was furnished with our Form 8-K today with the SEC and may also be found in the supplementary financial information available on our Investor Relations website at investors.knowbe4.com. In addition, some of our comments today, including those related to our guidance, may contain forward-looking statements that are subject to risks, uncertainties, and assumptions. Should any of these materialize or should our assumptions prove to be incorrect, actual company results could differ materially from those projected or implied during this call.\n\nThese risks are described in our Form 10-Q that will be filed in accordance with the filing deadlines established by the SEC. These documents can be found on the SEC's website, sec.gov, and on our Investor Relations website. During today's call, you will hear prepared remarks from our founder, CEO, and president, Stu Sjouwerman; and CFO, Bob Reich. Lars Letonoff, our chief revenue officer and co-president, will join our question and answer session.\n\nAnd with that, I will turn the call over to Stu.\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nThank you, Ken, and thank you all for joining us today. We are excited to share our results with you this morning. We've had another record quarter of strong execution with second quarter results exceeding our guidance. This has resulted in over 36% year-over-year annual recurring revenue growth and a strong 23.7% free cash flow margin.\n\nAs many of you know, I started KnowBe4 to help organizations manage the ongoing problem of social engineering. We're the only public company dedicated to securing the human layer, a layer that continues to prove itself exceedingly critical to organizations of all sizes, public or private. The environment that we find ourselves in today has transformed this even further. We believe that securing the human layer is a matter of national security.\n\nNow before I go through the highlights of our record performance, I first wanted to take a moment to talk about what this economic environment means for KnowBe4. I want to reiterate that while we are constantly monitoring all of our forward-looking metrics, we have not seen any material indication of a change in our sales pipeline that could impact our proven go-to-market strategy. Our investment philosophy remains on track as well, especially regarding international expansion. To specifically address our SMB segment, we continue to see strong logo and dollar retention.\n\nOur average selling prices for the segment continued to move up, which we view as an indicator that our platform is being prioritized in SMB budgets. Our lead and referral trends will remain healthy, leading to predictable close rates. This year, we also have a record number of active SMB quota-bearing reps onboard who are collectively producing excellent results. Historically, I have viewed these economic cycles as an opportunity to invest, which is a benefit that comes from running a streamlined organization with the kind of free cash flow that we have historically generated every quarter.\n\nWhile these economic conditions can bring challenges to most businesses, I think that KnowBe4 is positioned for continued expansion with the balance of growth and profitability. There are a few reasons why I can confidently say this. The first reason for my confidence comes from the industry that we're operating in. Cybersecurity budgets are resilient.\n\nIt is well known that the cybersecurity posture of an organization is crucial. However, the critical role that the human being plays in cybersecurity has only become clear within the past few years and is becoming more evident all the time. For instance, the 2022 Verizon Data Breach Investigations Report or the DBIR, which came out this last quarter, found that 82% of data breaches involve the human element. Organizations across the globe are experiencing increasingly frequent and debilitating data breaches, ransomware infections, and intellectual property theft, the vast majority of which are accomplished through social engineering attacks.\n\nWe believe that a secure human layer is absolutely mission-critical to reducing these risks. Phishing attacks, which the DBIR calls one of the four key paths to your stakes are continuing to rise as well. The Anti-Phishing Working Group published their latest report showing that phishing attacks have once again reached an all-time high in Q1 of 2022. Over 1 million attacks were detected during the period, more than tripling that of early 2020.\n\nThis equates to over one attack every eight seconds. And these bad actors only need to be right once. KnowBe4's platform is proven to reduce the risk of phishing attacks. The cost is a small fraction of the overall cybersecurity spend for many organizations.\n\nAnd some of you may have seen that IBM Security released its annual cost of a data breach report last week, which found that the average cost of a data breach in 2022 was $4.35 million. The second reason for my confidence is our market position. In spite of the success that we've seen so far, we still have a relatively low penetration in a global landscape that is predominantly greenfield. We're pioneering a category that is very much in the early days, all at a time when the geopolitical environment only continues to validate the need for our platform.\n\nThe ongoing conflict between Russia and Ukraine has shown the world what modern cyber warfare looks like. Tom Burt, the Head of Microsoft's Customer Security & Trust, just gave an interview last month, offering a glimpse of this destruction. According to Burt, 10 hours before the first missiles were launched and the tanks rolled over the border, there was a huge Viper attack across 300 different systems in government and private sector companies in Ukraine. For context, a Viper attack is designed to wipe out as much data as possible and cause maximum network destruction.\n\nWhile the conflict itself is tragic, things like these are helping the international community realize that the cybersecurity posture of every organization is a matter of national security. The final reason that I'm confident in our ability to execute during a potential economic cycle is that our customer base itself is resilient. Our logo retention rate for both SMB and enterprise continues to remain above 90% this quarter. This is a feat that we accomplished with over 52,000 customers in Q2 of 2022, over 46,000 of which we classify as SMB.\n\nCOVID taught us that the spending habits of our customers are resilient as well, but the only measurable impact to our existing customers being a reduction in their seat counts as some of our customers furloughed employees for the first few months. We believe this is because they are aware of the value of the platform, which comes at a cost that some of our smaller SMBs can just charge to a credit card. Keep in mind, during this time, we continued to grow the number of customers with multiple products. We remain committed to long-term execution and continue to see an environment that only favors this.\n\nA few highlights from our Q2 results are evidence of this. Second quarter results exceeded our expectations across the board with continued balanced growth in both top-line and profitability as well as strong free cash flow generation. This resulted in over $328 million in ARR, which is up over 36% year over year as of the end of Q2. We believe this performance demonstrates our market-leading position in the human-centric cybersecurity space.\n\nAnd we continue to remain focused on innovation in order to meet the needs of our customers. I am pleased to announce that this now includes KnowBe4 Ventures, a fund dedicated entirely to supporting innovation in the human layer. We are enriching this critical ecosystem by focusing on supporting organizations that build integrations with our platform and utilize our unique data. For years, we've discussed the mismatch between cybersecurity spend on the human layer and the risk that it actually represents.\n\nThe overwhelming majority of data breaches involve a human element, yet, less than 3% of cybersecurity budgets have historically been dedicated to reducing this risk. By focusing on early stage investments for organizations innovating within this space, we're helping to support and expand the human layer for years to come. This is all part of our Vision for the Security Awareness market, a vision that defines our own product roadmap as well. This includes both exciting new features and new products.\n\nA great example of this is Security Coach, the product we're planning to release in the second half of this year, resulting from the integration of our Security Adviser acquisition. With Security Coach, we believe we are creating a new category in cybersecurity called Human Detection & Response or HDR. How this works is we connect through a cloud interface to existing layers in our customers' security software stack and pull in security alerts to analyze and take real-time action. I am pleased to announce that Security Coach is currently in a closed beta with initial feedback being overwhelmingly positive.\n\nAn open beta is soon to follow with general release still planned for Q4. We showcased a number of our new features to the public at KB4CON 2022. Following the COVID environment of virtual conferences, it was refreshing to hold this one in person, and it was a great success. The number of attendees far exceeded our expectations.\n\nAnd the general feedback was overwhelmingly positive with surveys showing 96% of 2022 attendees planning to attend in 2023 as well. One feature that KB4CON visitors were particularly excited about is the KnowBe4 Mobile App. It is currently in a closed beta with plans for a general release in Q3 2022. This has been a common request from our customers who want their users to be able to complete their new-school security awareness training directly from their phone.\n\nWe believe that expanding our platform to mobile is the next step in boosting engagement and ultimately adds to the value that our customer base has grown to expect. As a reminder, we're operating in one of the few areas in cybersecurity, if not the only area that isn't purely a replacement market. While most of our new business wins are greenfield, we also continue to see a number of competitive displacements. The greenfield wins continue to show that the value of security awareness is resonating with customers.\n\nAnd we believe that our competitive wins are further proof that our platform and customer support are superior. Here are a few examples of our global wins that we've had this last quarter. We closed the largest deal in our history, a 243,000-seat opportunity with a State Department of Education. They cited the quality of our content and ease of deploying our platform across all districts.\n\nThat's the primary reason for their choice. Above all, they understood that their in-house training was inadequate given the current threat environment. We displaced a competitor in 100,000 seat deal with a top multinational conglomerate. They had been unable to create a security culture with their current offering and also found our PhishER platform to be superior.\n\nFinally, we won 100,000 seat deal with a multinational transportation enterprise. This was another great example of a large organization, realizing that the threat landscape we're finding ourselves in today, far exceeded their internal training capabilities and utilizing our platform was a no-brainer decision. The strong momentum we've been seeing in the international markets has continued as well. In Germany, we closed a 50,000-seat deal with one of the largest media conglomerates in the world.\n\nWe also closed a 50,000-seat deal with a Swiss multinational building materials manufacturer. In Africa, we closed a 10,000-seat deal with a large state oil and gas organization and we displaced a competitor for a 10,000-seat deal with a top multinational beverage company. Finally, we displaced a competitor in a 16,000-seat deal with an Italian medical device manufacturer. These are just a few examples of the types of wins that have become a common occurrence for us.\n\nWe believe that they demonstrate how our customers continue to embrace not only the considerable risk reduction our platform brings but also the thousands of hours we can save the IT department in triaging security events. Given the current shortage of skilled IT workers, our strategy of building time-saving features into our platform is paying off. This also remains a critical focus for our product roadmap. With that being said, I would like to thank our employees and partners for their dedication, commitment, and customer focus that has brought KnowBe4 to its market-leading position today.\n\nI am super proud of the great group of people driving this company and contributing to our communities. And with that, I would like Bob to discuss our financial trends.\n\nBob Reich -- Chief Financial Officer\n\nThanks, Stu, and good morning, everyone. Thanks again for joining us on the call today. We're pleased to be able to share our Q2 results with you this morning. This is my first full quarter here at KnowBe4, and it was very exciting to see the strong execution across the business, delivering another solid quarter of results.\n\nI'll be sharing more details on revenue, costs and cash flow for the second quarter. As a quick reminder, unless otherwise noted, all numbers except revenue mentioned during my remarks are non-GAAP. As you just heard from Stu, we continue to see strong revenue performance across our various go-to-market groups. In the second quarter, total annual recurring revenue or ARR, reached $328.3 million, compared to $240.6 million a year ago, up 36.5% year over year.\n\nSimilarly, our reported GAAP revenue for the second quarter totaled $80.8 million versus $59.4 million during the same period a year ago, an increase of $21.4 million or up 36.1% year over year. Our Q2 growth was driven by another strong quarter across each of our key growth initiatives; new logo expansion, cross-selling to new and existing customers, and international expansion. We continue to see strong execution in each of these areas during the second quarter. Let's start with our first pillar of growth, which is new logo execution.\n\nDuring the second quarter, we sequentially added nearly 2,600 logos net of churn, bringing our total customer count to 52,216 as of June 30th. That's a 25.5% increase year over year or over 10,600 new logos added net of churn. Our total customer distribution remains relatively consistent with about 88% of our customers in the SMB space, which we define as organizations of less than 1,000 employees, and about 12% in the enterprise space, which we define as organizations with greater than 1,000 employees where we've seen significant growth over the past few years. As a reminder, we remain focused on driving a balanced ARR mix between SMB and Enterprise.\n\nAnd we again ended the quarter with ARR generally balanced between these two. In terms of logo retention, both SMB and Enterprise retention again remained greater than 90% during the second quarter. We're particularly pleased with this continued strong retention rate in excess of 90%, especially when considering that our SMB customer base is over 46,000 customers. As Stu mentioned earlier, we're keeping a very close eye on all our leading indicators related to the health of this segment of the market, and all indicators remain positive.\n\nOur second pillar of growth is cross-selling to new and existing customers. During the second quarter, we continued to see strong multi-product adoption, resulting in the percentage of customers subscribing to multiple products growing to 26.3% from 24.5% previously. This brings the total number of customers with multiple products to over 13,700, a number that has grown by 94% from Q2 of last year. While we're proud that over one quarter of our 52,000 customers have multiple products, we also view this as a strong opportunity for continued expansion.\n\nThese are all users who understand the value of our KMSAT platform and continue to act as a rich source of leads to cross-sell into. We're seeing record levels of customers with three and even four products and all were closed without having to bundle products. And although we don't report growth of our individual products separately, our combined revenue growth for PhishER, Compliance Plus, and KCM GRC again reached over triple-digits year over year for the quarter. Our cross-sell success is relevant not only to help expand our ARR base, but also to increase customer retention.\n\nOur retention statistics support the customers who purchased both KMSAT and PhishER get more value from our platform, and as a result, end up being much stickier customers. Our third pillar of growth is expanding internationally. Penetrating international markets remains one of our key pillars of growth. Our international revenue grew 56.1% year over year and grew sequentially by $1.4 million from Q1, representing our strongest quarter of sequential growth from international in the last three quarters.\n\nThis complements our consistent domestic momentum, which delivered 32.5% year-over-year revenue growth during the second quarter. The geographic distribution of our revenue continues to evolve with revenue derived from international markets now representing 17.4% of our total reported GAAP revenue, up from 16.8% last quarter. Although the majority of our revenue continues to come from North America, we believe there's a sizable greenfield market for KnowBe4 internationally, represented by a total addressable market, which is significantly higher than that of domestic with key international regions at a similar inflection point previously seen in the domestic market. In order to capitalize on this compelling international opportunity, we continue to invest in both EMEA and APAC by focusing on hiring key go-to-market talent and expanding brand awareness.\n\nAnd this international execution strategy is also closely tied to us building on our growing partner network outside of the U.S., which is our fourth pillar of growth. We continue to make meaningful progress on hiring key resources in our channel team and building marketing and distribution capabilities for our channel partners. For an example of the meaningful contribution that our channel partners continue to make, the largest deal in KnowBe4 history that Stu mentioned earlier came through our domestic channel business, and this will continue to be an important international execution initiative for us. The other global wins mentioned during Stu's remarks also serve as examples of international investment strategy producing results.\n\nWhile we're still early on in our expansion within these markets, we're adding marquee global brands to our client base on a monthly basis. As part of our philosophy of managing the business, we remain focused on sustaining our high growth rate with strong profitability, and we delivered margin expansion again in Q2. Our second quarter non-GAAP gross margins improved to 87.9% from 85.9% a year ago as we continued to deliver an efficient performance in our direct cost structure. Our total non-GAAP operating margin also showed healthy improvement during the quarter, up to 13.5% from 7.6% in the second quarter of 2021, a demonstration of our ability to leverage our overall cost structure as we continue to scale.\n\nAs a reminder, our non-GAAP measures exclude stock compensation expenses, amortization of acquired intangibles, and acquisition and integration-related costs. Our total non-GAAP operating expenses for the quarter totaled $60 million, up from $46.5 million in the prior year, an increase of roughly 29%. We continue to invest in headcount across the business with total headcount increasing by about 33% versus the end of Q2 2021. This drove the vast majority of our operating expense increases.\n\nYear-over-year increases in non-GAAP sales and marketing expenses for the quarter were primarily attributable to higher headcount-related costs, including headcount-related subscriptions and overhead allocations as well as higher marketing, PR, and demand generation costs contributing to our revenue growth. It's also worth noting that our marketing spend on industry events also increased year over year as we shift back toward in-person events versus primarily virtual arrangements in the prior year, including an incredibly successful KB4CON customer event that we hosted in April. We continue to invest in sales capacity in our core markets. And while we are still in the early stages of international expansion, we expect to continue to deploy additional resources to support growth in these markets.\n\nNon-GAAP technology and development costs have increased year over year, primarily due to headcount increases across our product and content development teams. As we continue to expand our product offerings, you will see additional investments in key technical talent across the globe. These have been critical investments to support the development of the new products and features that Stu referenced earlier. The increases in non-GAAP general and administrative costs year over year are also attributable to investments in headcount and headcount-related costs, primarily to establish necessary administrative resources to support our international expansion and the ongoing life as a public company.\n\nThese included headcount investments across legal, finance, HR, and our own internal IT teams. We also saw an increase in non-headcount-related expenses related to professional services as we work to optimize and globalize our administrative systems. These investments are necessary to first build the foundational capabilities to ensure we continue to execute efficiently and at scale. We consistently try to highlight our balanced approach to both growth and profitability.\n\nAnd this is evidenced by our non-GAAP operating income more than doubling year over year, growing in Q2 by over 143% from $4.5 million in the second quarter of 2021 to $11 million in the second quarter of 2022. Let's now turn to cash flow and liquidity. We finished the quarter with cash and cash equivalents of $315.5 million, up from $273.7 million at 2021 year end, illustrating our continued focus on maintaining a high level of capital efficiency and utilization of our liquidity. We're excited to highlight that this utilization will also now include KnowBe4 Ventures.\n\nAs Stu mentioned earlier in his remarks, this is a program that is fully dedicated to supporting innovation in the human layer of cybersecurity. The purpose of this program is to provide early stage investments that support an ecosystem of organizations actively building integrations with KnowBe4's products. You'll note in our cash flow statement that we made $2.4 million of venture investments during the second quarter. Moving on to our free cash flow.\n\nWe generated $19.1 million of free cash flow in the second quarter, resulting in a free cash flow margin of 23.7%. This compares to free cash flow of $12.8 million and free cash flow margin of 21.5% during the same period a year ago. The free cash flow results for the second quarter were driven primarily by continued upfront cash collections related to our favorable sales performance and some timing-related cost efficiencies realized during the quarter. As we've discussed in the past, there is seasonality in our quarterly free cash flow margins, which has ranged anywhere from 22% to 39% over the last six quarters.\n\nThis is generally related to the timing of disbursements for expenses and investments during the year as well as profiling of sales contracts and billings throughout a given quarter. We're very pleased with our second quarter performance, which is indicative of our resilient cash-generating SaaS model and strong balance sheet, which is supporting a balance of top-line growth and healthy profitability. We're continuing to expand our resource pool, invest in new products and capabilities, while maintaining sustainable profitable growth as we lead this new category in cybersecurity. Before we go into guidance on future results, I just wanted to take a moment to dovetail on to Stu's remarks regarding the economic dynamics that continue to demand our attention.\n\nWhile we're constantly monitoring all of our forward-looking metrics, we haven't seen any material indication of the change in our pipeline, leads, quotes, referrals or anything at this time, significantly impacting our proven go-to-market strategy and our largely greenfield market opportunity. This is obviously a matter that we continue to monitor closely. For the third quarter of 2022, we expect total revenue in the range of $85 million to $86 million. For the full year 2022, we now expect revenue in the range of $333 million to $334 million, up from our prior guidance of $331 million to $333 million.\n\nThis revenue guidance is based on our current product mix expectations for 2022. As a reminder, our KMSAT product has a small portion of revenue that is recognized upfront. And as a result, variability in product mix can have an impact on our reported revenue. We believe our guidance reflects the current economic dynamics and an appropriate level of conservatism.\n\nWe also now expect free cash flow margin to be greater than or equal to 24% for the full year. And as I mentioned, there is seasonality in our free cash flow, which can result in variations from quarter to quarter. We believe this guidance is indicative of the strength of our operating model and ability to maintain a high level of growth with a balance of profitability. For modeling purposes, you can assume a diluted weighted average share count of between 182 and 184 million shares for both Q3 and full year 2022.\n\nAs we look forward to the remainder of 2022, we continue to be very energized by the growth and momentum we've seen in the business. We are laser-focused on maintaining our market leadership dedicated to the human defense layer and driving innovation around the new category of HDR, which we are excited to introduce to the cybersecurity ecosystem later this year. And with that, we'd like to open it up to any questions.\n\nOperator\n\nThank you. [Operator instructions] Your first question comes from Brian Essex from Goldman Sachs. Please go ahead.\n\nBrian Essex -- Goldman Sachs -- Analyst\n\nGreat. Thank you. Good morning and thank you for taking the question. Good to see the continued strong results.\n\nI guess, maybe, Stu, one question for you with regard to your focus on SMB growth and adding SMB quota sales reps. Can you help us maybe understand what the unit economics look like there? How scalable is that? And what does this motion look like to, I guess, maintain efficiency as you drive those efforts?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nYeah. Good question. You have to understand that this is still like at least 90% greenfield. So the amount of scale we can achieve is only really limited by our own ability to execute.\n\nWe are planning for the foreseeable future to continue to expand that team and really only talking about U.S. domestic. If you look at international, that is even a larger greenfield and a TAM that is six to seven times larger than U.S. domestic.\n\nNow international, we work with channel partners, and I'm sure that Lars a little later down can expand on that. So as was earlier mentioned, this is still an early stage in a brand new category. Does that answer your question, Brian?\n\nBrian Essex -- Goldman Sachs -- Analyst\n\nYeah. I think that's helpful. And maybe just a follow-up. Any insight you can give us around cap rates.\n\nIt looks like ARR per customer continues to grow really nicely. Is this primarily still KMSAT and PhishER or are you starting to get more kind of Compliance attach? And how might that differ domestically versus internationally?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nWhen it gets to the numbers, I generally defer to Bob. But generally speaking, yes, we have very healthy attach rates for PhishER and Compliance Plus starts to kick in nicely. But Bob can maybe give some additional color.\n\nBob Reich -- Chief Financial Officer\n\nHonestly, it has been very consistent around sort of the distribution of the attach rate. Compliance Plus had a very, very strong quarter. But to be honest with you, PhishER, had a really, really strong quarter sequentially in the second quarter as well. So there really hasn't been any sort of change in the dynamics or the distribution of the attach rate.\n\nBoth of those products are still attaching very strongly. And both of those products are obviously contributing to the increase in average ARR. And with respect to distribution domestically versus internationally, it's probably a little bit more biased toward domestically. Just the international deals are generally larger deals and those larger deals are usually starting with KMSAT.\n\nBut overall, the trends have been really, really consistent over the last several quarters and we really haven't seen anything unusual or changing in terms of those attach rates.\n\nBrian Essex -- Goldman Sachs -- Analyst\n\nReally helpful. Thank you very much.\n\nOperator\n\nYour next question comes from Shaul Eyal from Cowen. Please go ahead.\n\nShaul Eyal -- Cowen and Company -- Analyst\n\nThank you. Good morning, guys. Congrats on the consistent performance in a challenging environment. And maybe for Bob, gross margins remained absolutely healthy, coming better than expected.\n\nCustomers are purchasing additional modules. As we think about the second half, should we be expecting some gross margin moderation, or pretty much we should be within the same levels that we are at right now? And I have a follow-up.\n\nBob Reich -- Chief Financial Officer\n\nIt's interesting. It's the exact same question we had in the first quarter and I had -- and again, I had this little code word in my prepared remarks around an efficient performance on the direct cost structure. And we did -- honestly, we did see a better performance in the direct cost structure than was originally anticipated. Some of that is really around the fact that we are achieving more and more scale.\n\nAnd that is providing a little bit more efficiency in some of those people elements that reside in the direct cost structure, things like our customer relation manager population, our direct tech support. So we are seeing a little bit better efficiencies than we were originally expecting there. I do think though that there has been some delays in some of the hiring that we've been trying to do. And so we've normally biased.\n\nAnd I think we are biasing in terms of our own internal forecast that those margins could compress a little bit, but it really won't be very significant as we continue to add resources into the customer support side and the CRM side.\n\nShaul Eyal -- Cowen and Company -- Analyst\n\nUnderstood. And maybe Stu mentioned that Lars is going to contribute his fair share. So my next question is on the international opportunity. Is it more greenfield or is it more displacement-driven?\n\nLars Letonoff -- Chief Revenue Officer and Co-President\n\nSo yeah, international is absolutely more greenfield. If you look at the international markets, you have each of these primary markets are in a different level of maturity than we are here in the U.S., and we're kind of going after those in a different way. But when you talk about SMB, it's really 100% in greenfield opportunity for international. A little less so for Enterprise because with the bigger global-sized companies, they're well on the way to having something with regard to security awareness training.\n\nShaul Eyal -- Cowen and Company -- Analyst\n\nUnderstood. Thank you.\n\nOperator\n\nYour next question comes from Fatima Boolani from Citi. Please go ahead.\n\nUnknown speaker -- Citi -- Analyst\n\nHey. Good morning, guys. This is Mark on for Fatima. So maybe just to start off, thanks for the high-level views on your sales pipeline and go-to-market.\n\nBut in the current environment, we're really starting to frequently hear companies speak to sales cycle elongation. So to that matter, can you give us a sense of what you're seeing in your deal negotiations, especially on the Enterprise? And what type of impact is it having on your pricing, discounting, elasticity? And how you're maybe adjusting go-to-market if there are any adjustments?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nWe definitely monitor every single part of our sales cycle. And we're really not seeing any material changes in anything, be it number of opportunities coming in, our lead generation, our time for a sales cycle. I mean, everything up to this point seems to be cranking along as normal. We don't really see any changes as far as deal elongation, not really seeing the sales cycles extending either.\n\nEven with the -- like the war in Ukraine, we're actually seeing some of the sales cycles shorten, but I know that's more of just a temporary reaction to a horrible event there globally.\n\nUnknown speaker -- Citi -- Analyst\n\nAnd then maybe just a follow-on. Can you maybe dive a little deeper on the Security Coach side? Maybe give us a sense of how you expect the revenue monetization efforts to ramp there? And in terms of timing, magnitude that we can expect going forward?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nWe are currently in closed beta with very good results. We're going into open beta later in Q3. We're still scheduled to release this product in Q4. The expectations haven't changed.\n\nWe are still very excited about this new category. The TAM that we mentioned earlier is holding up. We haven't yet finished our pricing surveys and setting the final price. We have shown the product at a few trade shows with uniformly very positive feedback.\n\nSo you will see us release this product this year. I do not expect meaningful revenues in Q4. This is really a 2023 product.\n\nUnknown speaker -- Citi -- Analyst\n\nIt's great to hear. Thanks very much.\n\nOperator\n\nYour next question comes from Rob Owens from Piper Sandler. Please go ahead.\n\nRob Owens -- Piper Sandler -- Analyst\n\nGreat. Good morning and thanks for taking my question. Sales-related questions, I'm guessing, you'll shift it over to Lars. But wondering on customer acquisition and the 2,600 that you added relatively flat year over year and still a strong result.\n\nBut how should we think about that as we look at the back half of the year? Should that be relatively flat with what was a record customer acquisition year last year or do you think we could see some growth on that front? Thanks,\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nRob, we're just steady moving along at the same pace. So I would expect it to remain the way it is, just kind of flat, but I wouldn't expect to see any big accelerations in that. We are making some investments in international. And we should -- next year, those investments in international should start picking up, but I don't see any real material acceleration in that.\n\nLars Letonoff -- Chief Revenue Officer and Co-President\n\nNo. Let me add something there, Rob. Most cybersecurity companies would give away their right arm for adding 2,500 logos per quarter. So it may be flat.\n\nOn the other hand, it is fantastic execution.\n\nRob Owens -- Piper Sandler -- Analyst\n\nAbsolutely. And I guess, since it's a two question morning, you mentioned the large deal with the State Department of Education. Can you remind us your SLED Fed opportunity, especially as we enter the third quarter here? Kind of where you guys are at overall?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nSo SLED Fed has always been a huge part of our go-to-market. So we are seeing, I would say, especially in the SLED market and then also federal, what we're seeing now is previous we would be involved in pieces of these very large organizations and we've been kind of chipping away one piece at a time. And what we're seeing now is from that success that these huge mega organizations are now coming in and then saying, hey, we're hearing good things about you. You're in seven of 15 of our departments.\n\nWe want to come in and just buy for the entire organization at once. So we expect to see a lot more of that in the future. And that could accelerate as well in the federal space.\n\nRob Owens -- Piper Sandler -- Analyst\n\nGreat. Thanks.\n\nOperator\n\nYour next question comes from DJ Hynes from Canaccord. Please go ahead.\n\nDJ Hynes -- Canaccord Genuity -- Analyst\n\nGood morning, guys. Stu, I remember a couple of quarters back, you said you felt like this was the year where it made sense to take some margin and to try and grow a little bit faster. Just based on guidance, it seems like the thinking has changed a bit there. It doesn't sound demand-driven.\n\nSo curious if the initial plan was just too aggressive or what's happening there?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nIt's a good question because a couple of quarters ago we were thinking, well, we are going to invest as much as we can in international. And I said, listen, it's going to be a little lower. The reality is that we are moving internationally as fast as we possibly can, but it is going a little slower, like Bob indicated earlier. So we're just not spending the money that I was thinking I was going to spend.\n\nSo that really explains this higher margin percentage. Keeping it simple for the moment. Maybe Bob wants to hop in, but --\n\nBob Reich -- Chief Financial Officer\n\nDJ, honestly, it's -- Stu is absolutely correct. I mean, this is a sequence in our international expansion and things happen in a sequential manner. And so it doesn't make any sense for us to get one step ahead of a different step and spend money internationally that's not ultimately going to bear fruit and provide us with the return. So we're just working through that sequence and it's just taking a little longer than the original profiling suggested.\n\nDJ Hynes -- Canaccord Genuity -- Analyst\n\nYep. Makes sense and no one is going to push back on higher margins in this environment. Lars, maybe one for you. Just I'm curious, do you find customers are more ROI-focused in this environment or is this something that buyers just know that they need to have it? And the reason I ask, and it seems to me like spending upfront to potentially save money in the future isn't the easiest pitch in a tight spend environment.\n\nSo to curious how you manage those conversations?\n\nLars Letonoff -- Chief Revenue Officer and Co-President\n\nI don't really see a lot of change. I'm hearing a lot here and there on TV and what have you about economics. But we're -- our sales cycles aren't changing. The kind of the -- on the purchase side, offering terms or not offering terms or asking for that.\n\nWe're not seeing not changing where they're trying to do like multiple-year payments. It's just pretty much for us. What I'm seeing now is business as usual.\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nYeah. One small addition there. This is a critical layer in an organization's cybersecurity stack. The price is still a no-brainer.\n\nAnd the ROI question isn't necessarily front of mind. This is more we have to have this. We can't expose ourselves to employees clicking on phishing links. And so we honestly do not see that come up much.\n\nBob Reich -- Chief Financial Officer\n\nHey, DJ, I'll add to that. We're kind of a no-brainer price. This is not a relative to other technology spend. This is not an expensive item.\n\nAnd it has -- it's a huge bang for the buck.\n\nDJ Hynes -- Canaccord Genuity -- Analyst\n\nYup. Super helpful color, guys. Thank you. Congrats.\n\nOperator\n\nYour next question comes from Tal Liani from Bank of America. Please go ahead.\n\nMadeline Brooks -- Bank of America Merrill Lynch -- Analyst\n\nHi, Stu. It's Madeline Brooks on for Tal Liani. Just one question from us. The hiring plan.\n\nCan you talk a little bit how you're thinking about hiring as we're going into the slowdown? I know you said earlier too you've had some delayed hiring. So just how should we think about that in the second half of the year? Thank you.\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nYeah, Madeline. I generally see the business cycle as a great opportunity to expand. I've lived through two of these. We do not plan to slow down at all, especially our international hiring is ramping up because that is where a huge opportunity still lives that we want to capitalize on.\n\nAnd so the -- we're really behind our hiring targets, frankly, and that's also the reason why the margin percentages were up. I hope this is a short answer, but I hope it illustrates where we're at.\n\nMadeline Brooks -- Bank of America Merrill Lynch -- Analyst\n\nGot it. Thank you so much.\n\nOperator\n\nYour next question comes from [Inaudible] from Truist Securities. Please go ahead.\n\nJoel Fishbein -- Truist Securities -- Analyst\n\nHi. It's Joel Fishbein actually from Truist. I wanted to follow up, Stu, on your remarks with regard to your recent pipeline -- product pipeline. I know you have the products coming out in Q4.\n\nCan you talk about the remaining products? I know the pipeline is robust, and I'd love to hear some of the new add-ons that you're bringing to market soon.\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nJoe, our focus mostly is on Security Coach. That is a main thrust in the sense of companywide. There are many different sectors, we call them divisions, that are ramping up for this. That's R&D, but it's also the sales team, the marketing team is internal training, etc., etc.\n\nThere are a few other products that sit in the pipeline that we are working on, but we decided to focus this year on the Security Coach release because that is a major product that we find our customers are also looking forward to.\n\nJoel Fishbein -- Truist Securities -- Analyst\n\nGreat. Thank you.\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nThank you, Joe.\n\nOperator\n\nYour next question comes from Alex Henderson from Needham. Please go ahead.\n\nAlex Henderson -- Needham and Company -- Analyst\n\nGreat. I actually have two questions I'd like to ask. The first one is with Mimecast and Proofpoint having now gone to the private markets, has that changed the competitive environment? Has it changed the pricing with larger accounts? Any implications for the business? And how are they behaving in the private market?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nI think Lars is best positioned to give some color there.\n\nLars Letonoff -- Chief Revenue Officer and Co-President\n\nYeah, Alex. I think -- I would think the main thing that we're seeing with Mimecast and Proofpoint is the customers are coming to us. And I don't think they're getting the same level of service and quality that they had prior. So we're getting a lot more interest coming in the door on our product.\n\nAs with most acquisitions, that's typically the case, at least immediately. I don't see any pressure on pricing. We've been competing with these guys for many years. We really know exactly where we need to be on pricing, and I don't see them really pulling those in.\n\nThe one area that I would see pricing change on their side is when we're actively poaching their business, that's when you're going to see these guys do aggressive bundling or even, in some cases, give away the product for free in a bundle. But again, we're best-of-breed product. We sell our product really based on that on how the quality of the product. So it hasn't been a big threat to us.\n\nAlex Henderson -- Needham and Company -- Analyst\n\nThe second question I wanted to ask, but before I do it, I just want to compliment you guys. You guys really did a great job of laying out the fundamentals. It was almost like it was written by a sell-side analyst. It was exactly what people would want to hear.\n\nSo compliments there. But I wanted to go to the international side of it. I mean, obviously, it's a primary driver of growth and I have two questions related to it. The first is, what portion of the international is just simply multinational domestic companies here that are buying it into the international market.\n\nBut more importantly, as we look at the international customers, the economy in Europe, in particular, is under enormous stress. We've seen the U.S. exporting inflation to them with the 20% swing in the value of the exchange rate versus the euro and the pound. Pricing of a lot of products have gone up on top of that.\n\nSo they're looking at 20%, 30% cost increases for a lot of products in the tech field. The question I have for you is, a, how much of your businesses U.S. dollar denominated internationally? And second, more to the point, how are you handling that enormous increase in cost that they're absorbing given their budgets are probably flat? Are you giving them better discounts? Is there price pressure there? I assume that there isn't because your pricing is so low. But could you address that conceptual issue of how you're handling that?\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nI think that Bob is probably best positioned to give you some insights there, but I did want to quickly answer the first part of your question. The way we count our revenues, where the headquarters is, is where the sale lands. And so if we talk international, those sales are actually logos that are in other countries. And Bob will take it from here.\n\nBob Reich -- Chief Financial Officer\n\nWith respect to FX, the vast majority of all of our international revenue transactions are actually denominated in USD. We do most of our international business through channel partners and our channel partners ultimately end up sort of navigating the FX with the end users, with the end customers. So we are generally billing almost all of our international revenue in USD. There are some exceptions, but most of Europe is USD, all of the U.K., Ireland is USD.\n\nThere's a -- Germany is actually denominated in euros, but it's not super, it's not very significant. Overall, roughly 3% of our total revenues is denominated in currencies other than USD. So it's a really, really small number. That said, we do know -- and Lars can confirm this.\n\nWe do know that the sales reps in their negotiations with the channel partners obviously are taking into consideration the exchange rate impacts from a discounting standpoint. So I think there is sort of a natural -- there is a natural FX impact, even though we're being denominated. These transactions are being denominated in USD.\n\nAlex Henderson -- Needham and Company -- Analyst\n\nSo how are you handling it?\n\nBob Reich -- Chief Financial Officer\n\nWell, I mean, I think it ultimately ends up resulting in slightly higher discounts that are a proxy for the FX impact, even though it's being denominated in USD, which is sort of what you're predicting, right?\n\nAlex Henderson -- Needham and Company -- Analyst\n\nRight. Thank you very much. That's helpful.\n\nOperator\n\nYour next question comes from Hamza Fodderwala from Morgan Stanley. Please go ahead.\n\nHamza Fodderwala -- Morgan Stanley -- Analyst\n\nHey, guys. Good morning. Thanks for squeezing me in. Just one quick one for me, and I appreciate all the really great color earlier on the call.\n\nBob, this is for you. I think you said a pretty healthy pipeline. It seems like demand overall remained strong. Just as you look into the back half, you've got this healthy pipeline.\n\nAre you assuming a lower close rate on that pipeline just given some of the macro uncertainty? Any color you can give us around just the conservatism embedded in the back half?\n\nBob Reich -- Chief Financial Officer\n\nNo, Hamza. I actually -- I think when it comes to the guides, honestly, we've used the exact same sort of philosophy with respect to the guides of Q3 and full year. We guided roughly somewhere between 33% and 35% year-over-year growth in Q1 and Q2. We're doing the same thing in Q3.\n\nFull year now reflects an estimated, a little bit north of 35% year-over-year growth. So I don't think that there is any sort of change in assumptions and growth rates or anything that's that granular in terms of our calculus here. I think Q3, the level of precision is obviously pretty high and we're guiding very consistent with the way we guided Q2. I do think that there is just sort of a natural bias to be a little bit more conservative in terms of the full year, just given the fact that there are uncertainties.\n\nAnd even though we're not seeing anything, any sort of early indicators as we sit here on August 4th, we still have five months of the year to go.\n\nHamza Fodderwala -- Morgan Stanley -- Analyst\n\nThank you.\n\nOperator\n\nThere are no further questions at this time. I will turn the call back over to the presenters for closing remarks.\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nThank you very much for attending, and that really is all. Hope to see you in three months.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nKen Talanian -- Vice President of Investor Relations\n\nStu Sjouwerman -- Founder and Chief Executive Officer\n\nBob Reich -- Chief Financial Officer\n\nBrian Essex -- Goldman Sachs -- Analyst\n\nShaul Eyal -- Cowen and Company -- Analyst\n\nLars Letonoff -- Chief Revenue Officer and Co-President\n\nUnknown speaker -- Citi -- Analyst\n\nRob Owens -- Piper Sandler -- Analyst\n\nDJ Hynes -- Canaccord Genuity -- Analyst\n\nMadeline Brooks -- Bank of America Merrill Lynch -- Analyst\n\nJoel Fishbein -- Truist Securities -- Analyst\n\nAlex Henderson -- Needham and Company -- Analyst\n\nHamza Fodderwala -- Morgan Stanley -- Analyst\n\nMore KNBE analysis\n\nAll earnings call transcripts"}
{"id": "00431752-2227-4882-a06b-e25695215ba1", "companyName": "Infosys Ltd", "companyTicker": "INFY", "quarter": 3, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/01/13/infosys-ltd-infy-q3-2022-earnings-call-transcript/", "content": "Infosys Ltd\u00a0(INFY -5.57%)\nQ3\u00a02022 Earnings Call\nJan 12, 2022, 8:00 a.m. ET\n\nOperator\n\nLadies and gentlemen, good day, and welcome to the Infosys earnings conference call. [Operator instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Sandeep Mahindroo.\n\nThank you, and over to you, sir.\n\nSandeep Mahindroo -- Financial Controller and Head-Investor Relations\n\nThanks, Margaret. Hello, everyone, and welcome to Infosys earnings call to discuss Q3 FY '22 results. I'm Sandeep from the investor relations team in Bangalore. Let me begin by wishing everyone a very Happy New Year.\n\nJoining us today on this earnings call is CEO and MD, Mr. Salil Parekh; CFO, Mr. Nilanjan Roy; along with other members of the senior management team. We'll start the call with some remarks on the performance of the company by Salil and Nilanjan.\n\nAfter that, we'll open up the call for questions. Please note that anything which we say that refers to our outlook for the future is a forward-looking statement which must be read in conjunction with the risk that the company faces. A full statement explanation of these risks is available in our filings with the SEC, which can be found on www.sec.gov. I'd now like to turn it over to Salil.\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nThanks, Sandeep. Good evening and good morning to everyone on the call. Wish you all a Happy New Year and trust you and your dear ones are well and safe. Thank you for making the time to join us today.\n\nI am delighted to share with you that we had an extremely strong quarter with 7% sequential growth and 21.5% year-on-year growth in constant-currency terms. Our year-on-year growth was the fastest we have had in 11 years. The growth was broad-based across industries, service lines and geographies, driven by our differentiated digital and cloud capabilities. Our strong broad-based growth in a seasonally weak quarter is a clear testament to the enormous confidence clients have in us to help them accelerate their business transformation.\n\nThis has been made possible by the relentless commitment from our employees through these challenging times. I'm extremely proud, as well as grateful for their extraordinary efforts in delivering success for our clients. Our growth has been accompanied by resilient operating margins at 23.5%. We delivered these margins while keeping in the forefront our focus on our employees with increased compensation and benefits.\n\nOur digital business grew by 42.6% and is now 58.5% of our overall revenues. Within digital, our cloud work is growing faster and our Cobalt cloud capabilities are resonating tremendously with our clients. Some of the highlights of our results are: Revenues at $4.25 billion, where our growth 21.5% year on year and 7% sequential in constant currency; broad-based across all industry service line and geographies; all of our segments reported strong double-digit growth; large deals at $2.5 billion; on-site mix at 23.8% and utilization at 88.5%; operating margin's strong at 23.5%; free cash flow at $719 million. Attrition increased to 25.5%.\n\nOur quarterly annualized attrition was flattish on a sequential basis. We had a net headcount increase of 12,450, attracting leading talent from the market. We've increased our annual college recruiting target to 55,000, and Nilanjan will comment more on this. We remain comfortable with our ability to support our clients in their digital transformation journey.\n\nFinancial services grew at 15.5% in constant currency with broad-based growth across geographies and steady deal wins. Various subsectors like lending, mortgage, cards, payments, are seeing increasing demand and clients are driving cloud transformation initiatives to build resilient and scalable platforms. The retail segment growth was 19.8% in constant currency. Across sub verticals, we see increased client spend on digital transformation, including digital supply chain, omni-channel commerce and large-scale cost takeout initiatives to improve business resilience.\n\nWe signed six large deals in this sector -- in this segment during the quarter. The communications segment grew at 22.2% constant currency. Segment performance continued to improve, with ramp-up of recently one deal. Client budgets are focused on digital and customer experience programs, increasing networking infrastructure, cloud adoption and security, with emphasis on 5G rollout and innovation spend.\n\nEnergy, utilities, resources and services vertical continues its steady performance with 13.6% constant-currency growth and five large deal wins. We are seeing gradual improvement across various businesses as consumer spending continues to increase and clients focus on increasing technology transformation around areas like customer experience, cybersecurity and workload migration to the cloud. Manufacturing segment growth accelerated to 48.4% in constant currency with continued ramp-up of the Daimler deal and steady momentum in new deal wins. We see across-the-broad improvement within various subsectors and geographies and expect client focus to continue in areas like smart manufacturing, IoT, digital supply chain and connected products.\n\nHi-tech growth improved during the quarter to 18.9% in constant currency. Clients are seeing renewed momentum in terms of spending on digital transformation programs linked to customer, partner and employee engagement. Life sciences segment performance also improved further to 29.2% growth. Adoption of digital health, telehealth and patient access programs are resulting in significant uptake of cloud, IoT, patient-facing applications, patient portals and next-generation CRM work.\n\nWe had a very strong performance on our income tax program in India. Over 5.8 crore or 58 million tax returns were filed using the new system by the deadline of December 31, 2021. On the last day, over 46 lakh or 4.6 million tax returns were filed. And during the peak hour, over 5 lakh or 500,000 tax returns were filed.\n\nWe are proud to be supporting the digital strategy for India and for the government and working on this program for future modules that will be developed. Across digital services in Q3, we have been ranked as leader in 12 digital service-related capabilities, from artificial intelligence and automation, cloud services, IoT, engineering, modernization and big data and analytics. The strong overall performance stems from four years of sustained strategic focus on areas of relevance for our clients in digital and cloud, continuing reskilling of our people and deep relationships of trust our clients have with us. With the strong momentum in the business and the robust pipeline, we are increasing our annual revenue growth guidance from 16.5% to 17.5%, moving up to 19.5% to 20% in constant currency.\n\nOur operating margin guidance remains at 22% to 24%. With that, let me hand it over to Nilanjan for his update.\n\nNilanjan Roy -- Chief Financial Officer\n\nThanks, Salil. Hello, everyone, and thank you for joining the call. Let me start by wishing everyone a very happy and safe 2022. Q3 was another successive quarter of continued acceleration in revenues at 7% constant currency Q-on-Q growth and 21.5% constant currency year-on-year growth, the highest year-on-year growth in the last 11 years.\n\nDespite the Q3 seasonality, we registered strong broad-based growth across geos and verticals. Our largest geography, North America, grew at 21.4%, while growth in Europe accelerated to an impressive 27.2% year on year in constant-currency terms. Retail, communication, manufacturing and life sciences also saw 20% or higher year-on-year growth in constant currency. We won 25 large deals, and large deals being those with over $50 million TCV, totaling $2.5 billion of TCV, six in retail, five each in financial services, communications and energy, utilities, resources and services; two in manufacturing; and one in hi-tech and life sciences.\n\nRegion-wise, 16 were from the Americas, seven were from Europe and two from RoW. The share of new deals increased in Q3 to 24% within the large deal numbers. Client metrics improved further, with $100 million client count increasing to 37, an increase of eight year on year. We added 111 new clients in the last quarter.\n\nOperating parameters remained robust. Utilization was 88.5%, slightly lower than the previous quarter, easing some of the supply side pressures. On-site effort mix is up marginally to 23.8%. Q3 margins remained resilient at 23.5%, a marginal drop of 10 basis points versus previous quarter.\n\nThe major components of the sequential margin movements were as below: 80-basis-points impact due to comp hikes and promotions and other employee interventions, 46-basis-points impact due to the utilization decline; these were offset by about 20-basis-points benefit due to the rupee and other cross currency movements, a 50-basis-point benefit due to cost optimization and another 40-basis-points benefit due to SG&A leverage and other one-offs included therein. Q3 EPS grew by 11.2% in dollar terms and 13.1% in rupee terms on a year-on-year basis. Although DSO increased to 71 days due to higher seasonal billings, an increase of five days versus the last quarter, it is still a reduction of two days versus Q3 of prior year. Free cash flow for the quarter was healthy at $719 million.\n\nFree cash flow as a percentage of net profit was 93% for Q3 and 104% for the nine months to date. Yield on cash balances improved to 5.29%, compared to 5.13% in Q2. Our balance sheet remains strong and debt-free. Consolidated cash and investments at the end of the quarter stood at $4.28 billion after paying over $850 million of interim dividend during the quarter.\n\nReturn on equity increased further to 30.4%, an increase of 3% over Q3 of the prior year, driven by robust performance and consistent capital returns through share buyback and increased dividend payouts. On the employee front, voluntary long-term 12-month attrition increased to 25.5%. And as Salil commented, while LTM attrition continues to increase due to the tail effect, quarterly annualized attrition was flattish compared to Q2. We will continue to invest in all aspects of talent retention, including compensation, promotions, skill incentives, learning and career progression.\n\nWe have also simultaneously increased the pace of hiring, talent reskilling and the usage of subcons to prevent any impact on client commitments. We have added over 12,450 employees, talented employees, on a net basis in the last quarter which is the highest ever. Our global college graduate hiring program for this fiscal has been increased to over 55,000 versus the previous quarter number of 45,000. In India, over 93% of Infoscions have received at least one dose of the vaccine.\n\nOver 90% of our employees globally are presently working in a remote environment due to the heightened precautions against the new variant. Driven by robust demand environment and our continued market share gains, we are further increasing our revenue guidance for FY '22 to 19.5% to 20% in constant-currency terms from 16.5% to 17.5% earlier. And the margin guidance remains unchanged at 22% to 24%. With that, we can open the call for questions.\n\nOperator\n\nThank you very much. [Operator instructions] The first question is from the line of Ankur Rudra from J.P. Morgan. Please go ahead.\n\nAnkur Rudra -- J.P. Morgan -- Analyst\n\nThank you. Happy New Year to everybody. Excellent numbers for the quarter. Clearly, a very, very strong growth for the third quarter.\n\nCould you maybe start with elaborating where the incremental execution came from versus the previous full year forecast? Why was the difference so sharp?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nHi, Ankur, this is Salil. Sorry, you broke up a little bit. You said where was the incremental?\n\nAnkur Rudra -- J.P. Morgan -- Analyst\n\nWhere the incremental surprise came from. The full year guidance has been increased very sharply given the performance in the quarter. Where did the surprise come from?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nYeah, so there, I think, what we are seeing in the quarter and then all through the year is the demand environment remains extremely strong and then more and more traction on the digital and the cloud programs. This is where we saw the most impact in the quarter, in Q3, where we had this really strong growth of 7%, and therefore the overall guidance jumping up by 3%. In terms of verticals, as I was sharing earlier, it's really broad-based. Of course, we have very strong momentum in manufacturing.\n\nThat was something that we were looking forward to. There's also good momentum that we are seeing in financial services, given it's our largest vertical; and in life sciences that I described before. Retail is starting to come back nicely as well. As Nilanjan mentioned, Europe, again, was standout.\n\nThose are some of the elements that gave us a good outcome in Q3 and then the support for expanding the margin for the full year -- sorry, the guidance for the full year.\n\nAnkur Rudra -- J.P. Morgan -- Analyst\n\nThank you, Salil. Salil, the growth trajectory has continued on a year-over-year basis for the last six quarters already.\n\nOperator\n\nSorry to interrupt you, Mr. Rudra. Your voice again, it was breaking.\u00a0\n\nAnkur Rudra -- J.P. Morgan -- Analyst\n\nApologies. Let me try again, if you can hear -- growth trajectory...\n\nOperator\n\nI'm afraid -- sir, your voice is not clear. I would just request you to please check your phone line and rejoin the queue. In the meanwhile, we'll move to the next question, which is from the line of Moshe Katri from Wedbush. Please go ahead.\n\nMoshe Katri -- Wedbush Securities -- Analyst\n\nHey, thanks. Happy New Year, and congrats on very strong results. One, I know this is -- we just reported Q3. But are you ready to talk a bit about the entire calendar year down the road '22? What do we -- what's changed in terms of visibility? Maybe, I guess, the biggest question is gonna be if this is sustainable down the road.\n\nAnd what can you kind of talk about in terms of color to give us that comfort? And then, on top of that, maybe you can talk a bit about some of the cushion in margins and what sort of levers that you have in the model, especially as some of the bench continues to benefit from the off-campus recruiting that's been pretty robust. Thanks a lot.\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nThanks, Moshe. This is Salil. I'll start off with the first part, and then Nilanjan will comment on the margin levers. Of course, as you referenced, we have guidance through March 31, March 31 of this year.\n\nThe color for this calendar year, broadly, we see the demand environment remaining strong. The client budgets are looking good. Our overall pipeline is the largest we've had in a very long time. The number of large deals that we were able to close that Nilanjan shared, 25 large deals, each over $50 million for a total of $2.5 billion, and 44% of these are net new.\n\nSo all of those things are giving us good confidence for what we see going ahead. Of course, we will have our guidance for the -- for our financial year in April. Nilanjan, over to you, please.\u00a0\n\nNilanjan Roy -- Chief Financial Officer\n\nYes. Thanks, Salil. Moshe, so on the margins, like I mentioned earlier, they were quite resilient for the quarter. I think, a couple of things I just wanna call out.\n\nOf course, our many cost levers, whether it's the on-site/offshore mix, it's the pyramid, whether it's automation. Of course, these are something which we are continuously deploying. Going ahead, of course, subcon cost for us has really ramped up, and that's an area we will continue to look ahead. The other thing is, of course, pricing.\n\nAnd it's important to talk about that as the higher costs are now feeding into our new deals, etc. I think that should hopefully have a benefit. And of course, as digital talents are getting priced in, we are able to show value to our clients in terms of the business transformation. Now again, this is something we have started recently.\n\nIt will take time to kick in. And we've talked about it in the last quarter as well. But really, that is the focus which we can start getting into both our cost side and also making sure that we are not leaving any free cents and dollars on the table as part of our pricing negotiations.\u00a0\n\nMoshe Katri -- Wedbush Securities -- Analyst\n\nThanks, guys. Good luck.\n\nOperator\n\nThank you. The next question is from the line of Kumar Rakesh from BNP Paribas. Please go ahead.\n\nKumar Rakesh -- BNP Paribas -- Analyst\n\nHi. Good evening, everyone, and thank you for taking our question. Congratulations on great set of numbers. My first question, Salil, was around going into this calendar year.\n\nSo one of the largest peers of ours have indicated a very strong growth to continue through this year. So looking at our portfolio of capabilities and offerings, do you see that we are well aligned to meet or beat their growth numbers? Or do you see that we need some intervention to build up our own capability to continue this strong growth going ahead?\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nThanks for that question. I think, in terms of our capability set, we have a strong portfolio across digital and cloud. Our Cobalt set of capabilities is resonating extremely well with our client. We see the growth in digital is really a reflection of the focus we've had on making these choices over the past four years and positioning the portfolio for where the clients is immersed and looking for work.\n\nWe also see the cloud capability faster growing than our digital capability. So yes, we are well-positioned to benefit from this. In addition to that, we have a strong set of capabilities in automation, in modernization. We've even seen our core services, which is now stable this quarter in terms of growth, it's not shrinking.\n\nSo our view is that our set of capabilities and portfolio are reflecting what our client expectation, demand are. And we have the ability to meet all of those from the capability perspective. We also have the capacity with the expanded recruiting at the college level and our ongoing recruiting ability to attract talent, which is helping us to deliver on our projects on a regular basis. So we feel quite good about how we're positioned as we go ahead into the next year as well.\u00a0\n\nKumar Rakesh -- BNP Paribas -- Analyst\n\nThanks for that, Salil. My next question was around the margin guidance plan which we have, 22% to 24%. And currently, we are trending to the upper end of that. So how should we see that? What is it an indication of? Is it that you want to keep a flexibility with yourselves in anticipation of any large deal or any cost headwind potentially coming from that? Or is there an indication that you're looking at some major cost trends which are going to come in coming quarters, and hence, you are maintaining this margin guidance planned?\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah, so I think, the margin guidance for us is really a comfort range within which we operate. So we really don't fine-tune that as the year progresses. So this is a band which we are happy to be in. It was 21% to 23% just before COVID, now we are 22% to 24%.\n\nSo that's more like a rail for us rather than anything else. And I think, looking ahead, we continue to focus. We know our cost headwinds potentially in terms of employees, etc., could be travel into the next year. But like I said, we have a very robust cost optimization, and of course, new levers which we continue to deploy.\n\nSo we remain quite confident on this.\n\nKumar Rakesh -- BNP Paribas -- Analyst\n\nOK. So more of a reflection of flexibility that you want to keep with yourself. Got it. Thanks a lot for those answers.\n\nI'll fall -- be back.\n\nOperator\n\nThank you. The next question is from the line of Keith Bachman from BMO Capital Markets. Please go ahead.\n\nKeith Bachman -- BMO Capital Markets -- Analyst\n\nYes. Thank you. I want to pick up on that line of questioning. If you could just talk about the puts and takes as you see margins over the course of the next three, four, five quarters, really calendar year '22.\n\nAnd I wanted to see if you could address what you think the impact would be for a few things. So for instance, one of the headwinds this quarter was utilization. How should we be thinking about utilization trends during calendar year '22? Number two, could you speak to -- I think you said attrition was flat sequentially. How do you think about attrition trends over the course of calendar year '22? Do you think that they can move lower? Or is the market such that demand is so strong that attrition will probably remain elevated? And then, number three would be, you just brought up travel or any other issues that we should be thinking about that may impact calendar year '22 margins.\n\nAnd any other issues you want to bring up? And that's it for me. Thank you.\n\nNilanjan Roy -- Chief Financial Officer\n\nYes. So I think, like we don't give out the margin guidance for the next year. Now having said that, we're looking at the headwinds which we actually face pretty much every year. You have your compensation hikes, you have clients coming back for discounts on renewals.\n\nAnd some of that, you offset with the cost optimization programs which we run. And I mentioned that a bit earlier in terms of whether it's the pyramid, whether it's subcon, whether it's automation. New levers which we are looking at is pricing. So that's something which we are continuously working on and remain quite confident.\n\nOf course, travel is one thing which is quite unknown at this moment in terms of when does it come back? Even if it comes back, does it come back to pre-COVID levels or it will stay at a slightly lower level? So we'll have to watch out for that really. In terms of attrition, I think, it's a larger industry issue. It's not peculiar to us. And fundamentally, I think, it's largely stemming from that the volume increase for this industry fundamentally has to come from freshers, right? Otherwise, it's a zero-sum game in terms of somebody else's attrition is my backfill and my attrition is somebody else's backfill.\n\nSo as long as the fresher intake starts increasing because, first, they have to come into training, then they go into production after three or four months, and that will take time for this industry to start absorbing. And I think that's something which will help with the attrition in the medium term. And like I said, we have seen attrition flattening sequentially on a quarterly, annualized basis. And looking ahead, we are seeing some positive signs, but it's too early to say whether it will dramatically come down.\n\nBut like I said, as attrition -- as freshers feed into the system, we should see the overall environment in terms of attrition in the market really working.\u00a0\n\nKeith Bachman -- BMO Capital Markets -- Analyst\n\nOK, OK. But any comments specifically on, is utilization, you think, a help or hurt or neutral? Just broadly. And as part of that, I noticed your offshore percent of labor increased year over year. Is that also a trend that you think continues given the dynamics in front of you? And I will cede the floor thereafter.\u00a0\n\nNilanjan Roy -- Chief Financial Officer\n\nSure. So in terms of utilization, of course, this is higher than what we would normally like to be. We would rather operate at sort of an 85%, 86%. But having said that, even if we bring this down in the future, in terms of cost, it's largely offshoring, which -- because all the effort is -- 75% of our effort is sitting there.\n\nSo utilization doesn't directly link to the margin because of the way the offshore costs operate. So that's one factor. I think -- what was the second question on? On-site/offshore. I think, in the long run, I think -- long run, if you see, I think COVID, while it's had this huge impact on demand, I think the entire ability for the supply side to be delivered in a remote environment, really for me, is a shine-out because, really, that has opened up the eyes of many of our clients, that really, every sort of work doesn't have to be done nearshore.\n\nIt can be done -- or I mean, on-site. It can be done in nearshore locations, it can be done offshore. And I think, the beauty of that is, secularly, we believe this will help the industry in a much more larger offshoring at an overall level. And of course, part of that benefit will be more -- shifting more over to offshore locations.\n\nSo I think, this is a good sign. I think, there can be short-term impacts like we've seen this quarter, 10, 20 basis points here and there. But the secular trend, we think, we'll continue to see that the large labor markets available in India will open up a lot more offshoring opportunities.\u00a0\n\nKeith Bachman -- BMO Capital Markets -- Analyst\n\nTerrific. Many thanks. Congratulations.\n\nOperator\n\nThank you. The next question is from the line of Diviya Nagarajan from UBS. Please go ahead.\n\nDiviya Nagarajan -- UBS -- Analyst\n\nThanks for taking my question, and congratulations on a very impressive quarter from the team. My question is on pricing. Salil, we have seen now several quarters of strong demand, and it looks like we are looking at another year, looking at the run rate that we're exiting the calendar with, a pretty strong demand as well, and in just the supply in the last few comments that you made. How do you see pricing really trend in the next 12 to 18 months? Is there an opportunity for this to go up on a like-to-like basis?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nHi, Diviya, thanks for that question. This is Salil. I think, on pricing, first, we've seen some level of stability in what we saw in the specific deal that we closed in Q3 versus Q2. On the longer term, the revenue share in the past, we've put in place a very focused effort on communicating the value that we are helping create with our clients through the digital programs.\n\nWe are also seeing, as we've shared, wage increases. We've done three of them in the last 12 months. And broadly, we are seeing large enterprises, for the first time in a very long time, seeing inflation in their daily environment and so are more open to having these discussions. With these factors in line, we've seen -- we will see some more value that we can bring in through communicating and demonstrating our digital impact they will be creating through those programs.\n\nAnd that, while it will not be immediate, but over the next several quarters, in my view, will help us to build out more resilience in the margin profile.\u00a0\n\nDiviya Nagarajan -- UBS -- Analyst\n\nGot it. You earlier enumerated your skills and capabilities. But if you were to kind of think of any future investments that you were going to make, in which direction would you kind of direct that in terms of your skills and capabilities?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nSo today, the biggest drive within our clients is really cloud. Our Cobalt capabilities are very strong, and we are constantly announcing it. Whether we look at the public cloud partnerships, we have also a very strong ecosystem of private cloud partnerships. And we have a good ecosystem with the SaaS players, extremely strong cloud-native, cloud-first development.\n\nThose will be really the first area where we are already leading, but we will continue to grow. Then you have the areas which focus on cybersecurity, which focus on data and analytics, which focus on IoT. Those are the areas which we are seeing this incredible traction with our clients. Then with a very strong, innovative, modernization and automation, leveraging artificial intelligence and machine learning, we'll continue to build that out.\n\nOur approach is gonna be to drive all of these through our current margin profile. So that's what we will drive through as opposed to any new plays for [Inaudible].\n\nDiviya Nagarajan -- UBS -- Analyst\n\nFair enough. And one last bookkeeping question. Your Other segment had a big swing this quarter. Is there anything particular that we should be looking at here? Any one-off? Or is it something -- and if not, what drove that expense?\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah, so I'll take that. So that's coming from India. We had some seasonality with some of our clients toward wuarter end. And that you'll see also in the geography sector of India.\n\nDiviya Nagarajan -- UBS -- Analyst\n\nGot it. Thank you, and wish you all the best for the coming season.\n\nOperator\n\nThank you. The next question is from the line of Ashwin Mehta from AMBIT Capital. Please go ahead.\n\nAshwin Mehta -- Ambit Private Limited -- Analyst\n\nThanks for the opportunity, and congrats on a good set of numbers.\n\nOperator\n\nSorry to interrupt you, Mr. Mehta. I would request you to come closer to the phone.\u00a0\n\nAshwin Mehta -- Ambit Private Limited -- Analyst\n\nSorry. Can you hear me better?\n\nOperator\n\nYes, this is better. Please go ahead.\n\nAshwin Mehta -- Ambit Private Limited -- Analyst\n\nYeah, I had one question on the third-party bought-out items for service delivery. That item seems to have gone up by almost $71 million this quarter, almost 1.8% of revenues. So just wanted to check, what does this pertain to? And is it possibly related to the data center takeovers that we would have been done in some of our large deals?\u00a0\n\nNilanjan Roy -- Chief Financial Officer\n\nSalil, can I take that?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nYes, please go ahead.\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah. So I think, as we're looking in many digital end-to-end transformations, whether it's IT as a service, full stack transformation, these involve infrastructure, SaaS, data. So it's a full stack transformation. And in many cases, these involve infrastructure and software as well.\n\nSo these are bundled deals which are end-to-end transformations, and we think they're very, very important as well going ahead when we look at these digital transformations. So I think, as part of our overall deal profile, we continue to see these deals giving us increased visibility into the organization IT infrastructure and allowing us future deals ahead once we are pretty much front and center in the IT landscape. So that's what these are.\u00a0\n\nAshwin Mehta -- Ambit Private Limited -- Analyst\n\nOK, OK. Fair enough. And just one last question. In terms of our margin outlook over the near term, do you think, with the attrition starting to -- on a quarterly, annualized basis normalizing, the interventions that are required possibly go down in the near term so that we can possibly make a higher exit at the end of this year so that we can maintain margins in the next year as well?\n\nNilanjan Roy -- Chief Financial Officer\n\nYes. So like I said, we haven't seen a decline as yet. These are flattening and just probably will start inching off. So we will continue to do what it takes to invest behind our employees because we know this is more than the comfort range which would be happy in.\n\nSo I think, it's premature to say when this will really come off. But as of now, we are focused in doing all these interventions. This quarter, as said, like we mentioned, 80 basis points of our margin was behind these employee interventions.\n\nAshwin Mehta -- Ambit Private Limited -- Analyst\n\nOK. Thanks a lot. Congrats again, and all the best.\n\nOperator\n\nThank you. the next question is from the line of Sandip Agarwal from Edelweiss. Please go ahead.\n\nSandip Agarwal -- Edelweiss Capital -- Analyst\n\nYeah, hi. Good evening to the management team. Happy New Year, and thanks for taking my question. Firsrt of all, congratulations on a very good set of number.\n\nSo Salil, I have a very simple question. You see now, our core, which is 41%, 42% of the business, is stabilizing on a year-over-year basis. It is probably start -- a little growth is there. But digital continues to be at 40%-plus growth.\n\nSo if this trend continues next year, maybe our core will become 32%, 33% of the overall pie. So what is your sense from a long-term perspective? Where do you see this core stabilizing? Or do you think it will be very unfair to see them separately, and in next two, three years, you think everything will converge together? So any idea, anything which you can share on that front would be very helpful.\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nYeah, so thanks for that question. This is Salil. First, as you pointed out, the digital growth is very strong at over 40% at 42%. And that shows the resilience, the demand profile and our portfolio which is overlapping.\n\nThe key for the core, instead of looking at the percentage of the business, the key for us is really that core is now stable with a very small growth. So we didn't see the decline that we had for some quarters. And this makes it extremely strong for us. We have probably the best capability in automation and modernization across the industry.\n\nAnd with this, while everyone else's core is still shrinking, ours will be stable or possibly even have a small uptick, and that means we'll be the most competitive in this area. So I'm really looking at this as a very positive step. We of course have to maintain this, and we have to keep building out our automation capabilities. So if we succeed in that, I think that has a very good outlook for us in the quarters ahead.\n\nSandip Agarwal -- Edelweiss Capital -- Analyst\n\nYes. Thanks. That's very helpful, and best of luck for the current quarter. Thank you.\n\nOperator\n\nThank you. the next question is from the line of Nitin Padmanabhan from Investec. Please go ahead.\n\nNitin Padmanabhan -- Investec India -- Analyst\n\nYeah. Hi, good evening, and thanks for the opportunity. I had two questions. The first is on the employee side of things.\n\nI think, over the past, if you look at the employee cost under cost of revenue, it's consistently been, as a percentage of revenue, is actually below what it used to be pre-COVID. And a lot of the growth has actually been added on the subcon side of things. And even if you look at the numbers, it looks like most of the additions are all freshers. So keeping this dynamic in mind, just wanted to understand, as we go forward and maybe attrition sort of normalizes, how do you see this subcon sort of evolving from an operational perspective? Do you think you'll have to hire these subcontractors directly on to your roles? And would that involve slightly higher costs? How should one think of this dynamic overall? Was the first question.\n\nThe second question was around the digital proportion of the business has meaningfully gone up. And if you look into the next year, I'm sure it will be even higher. From that perspective, does that mean that our ability to sort of garner price increases will be far higher going into next year than what we see today? Thank you.\n\nNilanjan Roy -- Chief Financial Officer\n\nSo I'll take the first question on subcon. Really, and as Salil said, the demand environment is so strong that we don't want to leave anything on the table. And therefore, whether it's through subcon, whether it's through lateral or freshers, we will first intend to fulfill that demand. And of course, over a period of time, we will optimize that entire structure.\n\nSo whether it is a program to rehire some of this subcons, some of them we will, of course, elapse and we will get new lateral hires, somebody will promote from within. So that dynamic will play itself out over the next year. But at the moment, it's critical that we don't leave any demand on the table. And of course, this will remain an optimization lever for us.\n\nWe were one of the lowest in the industry at about 6.9% pre-COVID, and we are, I think, above 11% now. But this is a lever we will have over the medium term to optimize. Salil?\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nOn the pricing, the -- as the digital work will increase, what we have been putting in place, which is demonstrating to our clients the value creation through digital, will give us a larger opportunity for that because the revenue will be larger. So I think, your assumption is absolutely valid. We will have an additional ability to do that as long as we execute on that well.\n\nNitin Padmanabhan -- Investec India -- Analyst\n\nPerfect. Thanks for that. Just a clarification on the first answer. So on the first one, considering fresher additions are so strong this year and subcon is so strong, does it mean that next year, our ability to add as many freshers will be a little more inhibited in the sense that we'll need to focus a little more on laterals next year? Is that a way to think about it?\u00a0\n\nNilanjan Roy -- Chief Financial Officer\n\nNo, I don't think so. I think, we will continue to have a very robust fresher program. It's always been there. We have an internal -- strong internal rotation program.\n\nSo people will -- based on the skills they've taken through our reskilling program, we will move them to new projects, promotions. So in that sense, we think it will be a combination of both laterals and freshers as well. I don't think we see any change in that.\u00a0\n\nNitin Padmanabhan -- Investec India -- Analyst\n\nFair enough. Thank you so much, and all the very best.\n\nOperator\n\nThank you. The next question is from the line of Sandeep Shah from Equirus Securities. Please go ahead.\n\nSandeep Shah -- Equirus Securities Private -- Analyst\n\nYeah, thanks for the opportunity, and congratulations on a solid execution, both on revenue and margins. The first question is CY '21 or FY '22 had a benefit of mega deal wins, especially from Vanguard, as well as Daimler, as well as some amount of pent-up demand for you, as well as the industry. So the question is, entering into next year, do you believe that these elements, one has to take care in terms of tapering off any growth in the next year? Or do you believe the digital adoption journey, cloud adoption journey, which has a low penetration, which does not make us upset in looking in the next year in terms of the growth momentum as a whole?\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nSo thanks for the question. First, the guidance increase, as I'm sure you've seen, is for the year ending March of this year. We are not yet commenting in terms of quantitative guidance for next year. What is clear, nonetheless, is the demand environment remains strong and our portfolio of services and capabilities, especially on cloud and digital, are resonating well with clients, and we see a good pipeline for that.\n\nOur large deals in this quarter were also very strong. We continue to see a good large deal pipeline. We have seen a steady expansion of our clients over $50 million, $100 million, $200 million and so on. And so, we see that expansion within clients is working very well as well.\n\nAnd also, our new client wins, new accounts, are working well. So overall, we have the various elements of continuing this demand environment strongly. But we don't have a specific guidance yet for April 1, '22 -- year starting in April 1, '22.\n\nSandeep Shah -- Equirus Securities Private -- Analyst\n\nNo. No. Fair enough. And just last two bookkeeping question.\n\nThe way I look at it, the Daimler deal has two legs to ramp up, one being the deal and employee-related ramp-up and second being the pass-through data center-related ramp-up. Is it fair to say that most of these two legs ramp-up is largely behind? Or may continue in Q4, as well as 1Q of next financial year? And second, in terms of FY '22 wage hike, is it largely over? Or something is due in the fourth quarter as well?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nOn the Daimler, we don't have any more specific. I can understand what you're looking for, but we have not gone into that specific now with Q3 and Q4. And the overall guidance is increase of the revenue covers all of that, including Daimler and many other clients, and especially with Q4 and the seasonality of that quarter. In terms of salary and compensation increases, we have done three of them for this year.\n\nThere is nothing specific that is planned for Q4. We will start to look at what we will do in the next financial year that will come up. But nothing specific and being planned in Q4.\u00a0\n\nSandeep Shah -- Equirus Securities Private -- Analyst\n\nOK. Thanks, and all the best.\n\nOperator\n\nThank you. the next question is from the line of Manik Taneja from JM Financial. Please go ahead.\u00a0\n\nManik Taneja -- JM Financial Services Ltd -- Analyst\n\nThank you for the opportunity. Just wanted to understand, we've seen a significant increase in offshore mix of revenues over the last 18 months and this quarter saw a slight aberration. What caused that? And how do you see this metric going forward? Thank you.\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nThis is Salil. The mix has changed over the last 18 months with a lot of the -- has been put -- working -- that was put in place, work from home, allowing the work to be delivered from a different location with tremendous ease and efficiency. What we saw in the last quarter was a little bit thing that opened up in terms of travel. We've also been extremely optimal in what we have done in the previous quarters.\n\nAnd this is something that has given us more ability to drive connects with clients and grow. We see, in the medium term, a tremendous opportunity for an efficient mix because clients have also seen that, once the work is done remotely or work from home, that more opportunity exists for that work to be done from a location farther away. So in general, as a medium-term trend, we see that as a positive trend. We will have, of course, each quarter, some movements up and down.\n\nBut as a longer-term trend, we see that as a positive.\u00a0\n\nManik Taneja -- JM Financial Services Ltd -- Analyst\n\nThank you. I had one more additional question. Just wanted to get your thoughts around what we are seeing from a revenue productivity metric standpoint, or revenue per person standpoint. And while there is a significant amount of offshore shift over the last 18 months, we have seen utilization go up.\n\nSo what's causing the increase in revenue productivity despite the significant offshore shift that we've seen over the last 18 months? If you could talk about some of the factors that are driving that. Thank you.\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nOn the revenue productivity, there are a number of things that are going on. We see some of the mix of our work which is also changing more to digital. And there, we see much more revenue productivity coming in. As you pointed out, utilization has also gone up.\n\nWe are also seeing some of our work, for example, on the consulting side, the data and analytics side, growing really well, and that's giving us some level of a boost. There is also some impact which we've not quantified externally on leveraging some amount of automation and platforms that gives us this benefit. So there are several factors we then work despite the mix -- onshore/offshore mix changing.\u00a0\n\nManik Taneja -- JM Financial Services Ltd -- Analyst\n\nSure. Thank you, and all the best for the future.\n\nOperator\n\nThank you. The next question is from the line of Ruchi Burde from BOB -- sorry, BOB Capital Markets. Ruchi Burde, your line has been unmuted. We lost the line.\n\nSo we'll move to the next question, which is from the line of Rahul Jain from Dolat Capital. Please go ahead.\n\nRahul Jain -- Dolat Capital Market Private Ltd -- Analyst\n\nYeah, hi, thanks for the opportunity, and congratulations on the strong numbers. I have a question regarding the core revenue, which has seen a stabilization in this year. I think, you've addressed this point partly, but wanted to understand what could be the prospect for this side of the revenue in the coming years, especially when we talk about so much shift to digitalization? So what should be the prospect out here? This is the question number one.\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nSo there, we have no individual guidance for digital or for the core in that sense which is -- even for Q4 or for the next financial year. But structurally, what is clear is we have been successful in driving automation and modernization well. We make sure that we are probably the most competitive large player in the market working with large player in the markets, working with large and [Inaudible] in the last fall. We continue to execute under an ongoing activity, automating bulk, modernizing for us.\n\nIf we can continue to execute on that, my view is we earn that again. And that will have its own benefits in the medium term.\u00a0\n\nRahul Jain -- Dolat Capital Market Private Ltd -- Analyst\n\nRight, right. I appreciate the color. One more thing on the taxation part. Our tax rate steadily has been upwards of 27% on an average.\n\nThis looks a little higher given the kind of country that where most of our earnings belongs to. So any flavor you can share in terms of what should be the ideal tax rate on a sustainable basis and in near term?\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah, so I think, our tax rate has always hovered around this 27%, 28% range. And I don't think you'll see much movement going against it because, in any case, as you know, the India-only rate, because it is India-only, plus countries which are there, that's a 25%, India-only. So I think, in the long run, you will be around this range itself.\u00a0\n\nRahul Jain -- Dolat Capital Market Private Ltd -- Analyst\n\nSo which region profitability is -- or tax rate are much higher than the 25% rate? Also for taking this number higher than the average for India itself?\u00a0\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah. So we can't give that individually, but there are some jurisdictions, and also in some jurisdictions where those tax cannot be set off here as well. So it's a combination of both.\u00a0\n\nRahul Jain -- Dolat Capital Market Private Ltd -- Analyst\n\nOK, OK. So if we are not able to set that out -- that result in double taxation, and to jurisdiction. That is also the reason. OK.\n\nGot it. Thank you so much.\n\nOperator\n\nThank you. the next question is from the line of James Friedman from Susquehanna. Please go ahead.\n\nJamie Friedman -- Susquehanna International Group -- Analyst\n\nHi. Let me echo the congratulations, it's Jamie at Susquehanna. I just had one simple question, perhaps for Nilanjan. Can you remind us what the capital allocation strategy is? I remember you had put it out, I think, at the analyst day in November 2020.\n\nBut where is share repurchase in the prioritization? Thank you.\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah, so what we had announced in FY '20 basically was that we had taken our capital allocation to 85%. It was at 70%. And we said that we will pay this out over a period of five years through a combination of progressive growth-oriented dividend policy, plus either share buybacks or one of the special dividends. And in the first two years, as we announced, we have actually paid back 83% through higher -- increased normal dividends and also through this share buyback which we announced last year.\n\nSo we've already paid back 83%, and we remain quite committed to our overall 85% five-year number.\u00a0\n\nJamie Friedman -- Susquehanna International Group -- Analyst\n\nGot it. Thank you so much.\n\nOperator\n\nThank you. The next question is from the line of Vimal Gohil from Union AMC. Please go ahead.\n\nVimal Gohil -- Union Mutual Fund -- Analyst\n\nYeah, thank you for the opportunity, and congratulations on a great quarter. My question is on your employee costs, which partially has been addressed. But how should we think about the core employee cost growth, which comes under the cost of revenue, which has been around 4% sequentially here over the last -- over Q1 of FY '21 versus a 6% revenue growth? And this has been in light of a very sharp increase in attrition and, of course, other supply challenges and etc. So if you could just highlight, I mean, what -- how has the company sort of -- are our wage hikes in line with the industry? Or have they been much, much higher than the industry? How should we think about this historically? And if you could give some kind of an outlook over there as well.\n\nThanks.\n\nNilanjan Roy -- Chief Financial Officer\n\nYeah. So you have to see both employee cost and subcon together. So the cost of people is a combination of both, you can't see one in isolation. That's number one.\n\nNumber two, from an overall cost perspective, we of course are very focused on attrition and being competitive in the market, as well as being an employer of choice for many of our employees going ahead. So we look at interventions on the compensation side. Like Salil said, in Q1, Q2, we did across -- in January, we did across the board. In July, we've done across the board.\n\nIn Q3 as well, we have done very segmented and targeted on talent. And we'll continue doing that into Q4, etc., and looking at high points of attrition and doing it much more tactically to see where we are seeing demand being high in the market for those skills and target those employees, really. So I think, it is very nuanced and, like I said, a horses for courses, and we will continue doing that.\u00a0\n\nVimal Gohil -- Union Mutual Fund -- Analyst\n\nRight. And sir, how should we think about -- so basically, if we were to look at your guidance versus your implied -- your guidance implies a 0% to 2% sort of revenue growth in Q4. Considering the fact that there were some furloughs in Q3, your revenue growth would be -- could be higher than what you've reported in Q3. So how should -- is your guidance conservative at this point in time? How should we think about that?\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nIn terms of the guidance, it's a very strong guidance, which is 19.5% to 20%. There is no further color in saying whether it's conservative, aggressive or sort of stable. We see a very good demand outlook. We see good large deals and good growth for the year.\n\nBut the guidance is, I think, a very big move up from where we were in the last quarter.\u00a0\n\nVimal Gohil -- Union Mutual Fund -- Analyst\n\nFair enough. Thank you so much, and all the very best.\n\nOperator\n\nThank you. Ladies and gentlemen, that was the last question for today. I now hand the conference over to the management for closing comments.\u00a0\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nThank you, everyone. This is Salil, just to close from our side. First, thank you all for taking the time. We feel extremely good about the quarter, 7% growth Q on Q, 21% year on year.\n\nVery strong digital, 42%. Very good on large deals, $2.5 billion. So overall, really excellent market demand. And we are seeing market share gains, which is a very good sign for us, primarily which are coming from a well-positioned portfolio and a good execution from all of our teams.\n\nOur revenue guidance, of course, has gone up 19.5% to 20%. Our operating margin remains at a good level at 23.5%. And we have very good, strong trust and confidence of our clients; overall, a strong outlook; and positive about what we see in the future for our digital and cloud transformation programs. So with that, thank you all.\n\nI wish you a Happy New Year. And look forward to catching up in April.\n\nSandeep Mahindroo -- Financial Controller and Head-Investor Relations\n\nThanks, Salil, for the closing comments, and thanks, everyone, for joining us on this call. We look forward to talking to you again during the year. Thank you.\u00a0\n\nOperator\n\n[Operator signoff]\n\nDuration: 86 minutes\n\nSandeep Mahindroo -- Financial Controller and Head-Investor Relations\n\nSalil Parekh -- Chief Executive Officer and Managing Director\n\nNilanjan Roy -- Chief Financial Officer\n\nAnkur Rudra -- J.P. Morgan -- Analyst\n\nMoshe Katri -- Wedbush Securities -- Analyst\n\nKumar Rakesh -- BNP Paribas -- Analyst\n\nKeith Bachman -- BMO Capital Markets -- Analyst\n\nDiviya Nagarajan -- UBS -- Analyst\n\nAshwin Mehta -- Ambit Private Limited -- Analyst\n\nSandip Agarwal -- Edelweiss Capital -- Analyst\n\nNitin Padmanabhan -- Investec India -- Analyst\n\nSandeep Shah -- Equirus Securities Private -- Analyst\n\nManik Taneja -- JM Financial Services Ltd -- Analyst\n\nRahul Jain -- Dolat Capital Market Private Ltd -- Analyst\n\nJamie Friedman -- Susquehanna International Group -- Analyst\n\nVimal Gohil -- Union Mutual Fund -- Analyst\n\nMore INFY analysis\n\nAll earnings call transcripts"}
{"id": "0066013c-b695-472d-9d59-016029a976df", "companyName": "Reinsurance Group Of America Inc", "companyTicker": "RGA", "quarter": 3, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2021/11/05/reinsurance-group-of-america-inc-rga-q3-2021-earni/", "content": "Reinsurance Group Of America Inc\u00a0(RGA -2.11%)\nQ3\u00a02021 Earnings Call\nNov 5, 2021, 10:00 a.m. ET\n\nOperator\n\nGood day and welcome to the Reinsurance Group of America third quarter 2021 Results Conference Call. Today's conference call is being recorded. At this time, I would like to introduce Mr. Todd Larson, Senior Executive Vice President and Chief Financial Officer; and Ms. Anna Manning, President and Chief Executive Officer. Please go ahead, Mr. Larson.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nThank you. Good morning and welcome to RGA's third Quarter 2021 Conference Call. With me this morning on the call is Anna Manning, RGA's President and Chief Executive Officer; Leslie Barbi, Chief Investment Officer; Jonathan Porter, Chief Risk Officer; and Jeff Hopson, Head of Investor Relations. We will discuss the third quarter results after a quick reminder about forward-looking information and non-GAAP financial measures. Following our prepared remarks, we'll be happy to take your questions. Some of our comments or answers to your questions may contain forward-looking statements. Actual results could differ materially from expected results. Please refer to the earnings release we issued yesterday for a list of important factors that could cause actual results to differ materially from expected results. Additionally, during the course of this call, information we provide may include non-GAAP financial measures. Please see our earnings release, earnings presentation, quarterly financial supplement and website for discussion of these terms and reconciliations to GAAP measures. And now I'll turn the call over to Anna for her comments.\n\nAnna Manning -- President and Chief Executive Officer\n\nGood morning everyone, and thank you for joining our call today. Last night we reported a loss of $1.11 in adjusted operating EPS which included pre-tax $500 million in COVID 19 impacts, or $5.59 per share. Our 12 month trailing ROE was 2.1%, which included 9.8% in COVID 19 impacts. Premium growth was strong at 9.5% and we ended the quarter with excess capital of $1 billion. This quarter saw elevated COVID 19 claims in the US, India and South Africa, consistent with the levels of general population mortality. In the US individual mortality business, COVID 19 claims were $235 million in the quarter, slightly above the high end of our rules of thumb range. We also had a level of excess non COVID 19 claims reflecting the elevated levels of excess mortality reported in the general population by the CDC. COVID 19 claims in India and South Africa were $161 million and $64 million respectively as those countries also experienced a material delta wave, and Jonathan will provide further insights on our claims shortly. The performance this quarter ex COVID 19 was strong and featured many highlights again demonstrating the value of our diversified global business and the strength of our new business franchise. The highlights this quarter include strong earnings across all lines and regions from our GFS business, deployment of $140 million of capital into in-force transactions, including our largest to date longevity transaction in the Netherlands. This brings the year-to-date capital deployment into in-force transactions to a total of $440 million putting us on track for a very strong year as our pipelines remain very good with opportunities in all regions. I am particularly pleased with the recent success in our GFS business in Asia. That business has grown from a relatively small base a few years ago, the one that has produced $66 million of adjusted operating income through the first nine months of this year. Our success is in large part the result of our high-caliber local teams working together with our global product and risk experts to bring new solutions that best fit the needs of the local markets and clients. We are actively managing our capital position, balancing deployments into organic business and attractive in-force block opportunities with shareholder dividends, and in this quarter the resumption of share buybacks. And we generated additional capital with the completion of a financially attractive asset intensive retrocession transaction, I believe clear evidence of an efficient and effective capital management approach. Investment results were favorable in the quarter despite the continued challenges of below market yields, impairments were minimal, and we realized some nice gains in our limited partnerships in real estate joint ventures. Both our US Group and US individual Health business performed above our expectations, continuing a recent trend. As I think about this quarter and the last six quarters on the pandemic, I remain encouraged by the resilience of our global business and by the positive momentum in our new business opportunities and growth prospects. Looking forward, we expect some continuing impact from COVID 19 claims but believe these will be manageable endpoint to increasing vaccination rates globally as a reason for optimism. We operate from a position of strength with an outstanding workforce, valued client relationships, and healthy business fundamentals. We have a strong balance sheet and a track record of successful execution against our strategy. All this gives me confidence in our business and in our opportunities for growth. Even though a lot of the focus this quarter is on COVID 19 claims, we are accomplishing a lot in terms of adding substantial new long-term value. I'm proud of this team and all that we've achieved and I am excited about the future, and look forward to sharing more thoughts at our Investor Day on December 9. Thank you for your interest in RGA. I hope you all remain safe and stay well, and let me now turn it over to Todd to go over the detailed financial results.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nThanks. Anna. RGA reported a pre-tax adjusted operating loss of $89 million for the quarter and adjusted operating EPS loss of $1.11 per share which includes a negative COVID 19 impact of $5.59 per share. Our trailing 12 months adjusted ROE was 2.1% which is net of COVID impacts of 9.8%. While we did experience a significant level of COVID 19 impacts, our underlying non-COVID 19 results were strong as demonstrated by the year-to-date growth in our book value per share excluding AOCI of 4% to $137.60. I would highlight this growth in book value per share is after absorbing approximately $1 billion pre-tax of COVID 19 claim costs. Consolidated reported premiums increased 9.5% in the quarter, or 7.7% on a constant currency basis. Reported premiums did reflect a couple of one-off items where organic growth was very good and new business activity is encouraging across all regions. The effective tax rate for the quarter was 15.2% on pre-tax adjusted operating loss below our expected range of 23% to 24% primarily due to adjusted operating income and higher tax jurisdictions and losses in tax jurisdictions, for which we did not receive a tax benefit. This was partially offset by favorable adjustments from tax returns filed in the quarter.\n\nTurning to the segment results as listed on Slide 6 of the earnings presentation, the US and Latin America Traditional segment included approximately $250 million of COVID 19 claim cost, approximately $235 million of which was in our US individual mortality business and the balance in our US Group business. We saw non COVID 19 excess claims of approximately $75 million, which is consistent with higher non-COVID 19 population mortality as per CDC reporting. The US Group and individual Health business both performed better than our expectations due to favorable experience overall, even after reflecting $15 million of COVID 19 claims in our US Group lines of business. Variable investment income was strong in the quarter as both limited partnership performance and real estate joint venture realizations were favorable. The US Asset Intensive business reported very strong results. The segment had favorable overall experience and higher variable investment income. We continue to be pleased with the results in this segment. The Canada Traditional segment results reflected favorable experience in the group and creditor lines of business, slightly offset by COVID 19 claim costs in individual life -- line of approximately $5 million. The Canada Financial Solutions segment results reflected modestly unfavorable experience. In the Europe, Middle East and Africa segment, the Traditional business results reflected COVID 19 claim cost of $80 million in total, of which $64 million was in South Africa, and $13 million in the U.K. We also saw some excess mortality claims believed to be directly or indirectly COVID 19 related. EMEA's Financial Solutions had a good quarter as business results reflected favorable longevity experience, $4 million attributable to COVID 19. Turning to our Asia Pacific Traditional business, Asia results reflect COVID 19 claim cost of $169 million of which $161 million was in India. This impact was higher than our expectation and Jonathan will provide further information in a few minutes. Australia reported a small loss for the quarter. We continue to take necessary actions to manage the business back to consistent profitability. The Asia Financial Solutions business had a good quarter reflecting favorable experience and strong growth in new business. As Anna mentioned, we continue to be pleased with the growth and contributions from this segment. The Corporate and Other segment reported pre-tax adjusted operating loss of $27 million, which is in line with our quarterly average run rate.\n\nMoving on to investments, the non-spread portfolio yield for the quarter was 4.95%, reflecting both our well-diversified portfolio allocation and strong variable investment income primarily due to realizations from limited partnerships and real estate joint ventures. While hard to predict from a timing perspective, variable investment income is a core part of our investment earnings. The investment portfolio average rating was unchanged in the quarter and investment credit impairments were again nominal. Our new money rate increased to 3.7% with the majority of purchases in public investment grade assets and contributions from strong private asset production. Regarding capital management, our excess capital position at the end of the quarter was approximately $1 billion. Our capital position remains strong and we have ample liquidity. We deployed $140 million into in-force transactions and repurchased $46 million of shares. Additionally, we entered into an asset intensive retrocession transaction that generated $94 million of capital and enhanced our returns. This quarter highlights our balanced approach to capital management and our ability to absorb the impacts of COVID 19, fund organic growth, deploy capital into transactions, and return capital through share repurchases and dividends. I will now turn the call over to Jonathan Porter, our Chief Risk Officer, who will provide additional comments on our COVID 19 related experience.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nThanks, Todd. I'm going to review our Q3 claims experience and then provide some views on our COVID claim cost expectations for Q4. The global emergence of the delta variant has been a key driver of higher general population mortality in the quarter. We were optimistic in our last earnings call that trends in the US would lead to an improvement in mortality over the remainder of the year. However, Q3 saw increases in both COVID 19 and non-COVID 19 general population mortality. As you will see on slide 12 of our earnings presentation, the US population graphs show the level of COVID 19 reported deaths and the number of non-COVID 19 excess deaths over the course of the pandemic. There are three key takeaways. COVID 19 reported deaths increased substantially in the quarter. COVID 19 deaths under the age of 65, ages where there is more life insurance exposure were at their highest points over the past six quarters. Non-COVID 19 excess deaths were at their highest relative and absolute level since the start of the pandemic. Our individual mortality claims results --sorry, US individual mortality claims results are consistent with what was happening in the general population. COVID 19 claim costs were $235 million in the quarter, slightly above the higher end of our rule of thumb. Q3 results reflect higher mortality in ages under 65 and larger average claim sizes. On a year-to-date basis, COVID 19 claims are at the midpoint of our range. Our excess non-COVID 19 experience was also driven by higher claims frequency consistent with the elevated deaths in the general population. Turning to markets other than US individual mortality COVID 19 claim costs of $161 million in India were higher than our prior estimates, reflecting the more adverse impact of the Q2 delta wave. Similar to what we are observing in the US, the Delta Verint has resulted in higher general population deaths, a shift of deaths to younger more insured ages and a larger average claim size. $30 million of this impact in the quarter relates to an increase in IBNR, resulting in a COVID specific IBNR balance for India of $75 million at the end of the quarter. COVID 19 claim costs in South Africa are estimated at $64 million in the quarter, reflecting a change in the distribution of general population deaths by province, as well as some large claims volatility. Q3 general population data indicates that provinces with higher socioeconomic levels and therefore more insurance penetration and larger sized policies were more adversely impacted this quarter. Other markets including Canada and the U.K. accounted for $30 million of estimated COVID 19 claim costs. As expected, our longevity offset was modest in the quarter given relatively low levels of general population deaths in the U.K. where our longevity business is concentrated. Looking ahead to Q4, elevated levels of excess general population mortality are continuing in the US through October, although currently running at lower levels and experienced at their peak in September and trending downward. We are maintaining our claim cost rule of thumb of $10 million to $20 million for every 10,000 general population deaths. We are also maintaining our rule of thumb for the U.K. and Canada at this time. General population COVID 19 deaths in India and South Africa have been relatively modest through October. Predicting COVID 19 claim costs continues to be challenging in particular in India where comprehensive data is not available about. Although India and South Africa vaccination levels are still below our other key markets, they have increased materially in both countries since the beginning of Q3, which will reduce the scenario of future COVID 19 impacts. We remain confident that the impacts will be manageable. Let me now hand it back to Todd.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nThank you, Jonathan. Before opening it up for questions, I would like to remind you of our upcoming Investor Day scheduled for December 9. We hope you can join us for our discussion. We now like to open it up for questions.\n\nOperator\n\nThank you. [Operator Instructions] In the interest of time, please keep to one question with one follow-up. We will take our first question from Humphrey Lee of Dowling Partners. Please go ahead, your line is open.\n\nHumphrey Lee -- Dowling and Partners -- Analyst\n\nGood morning, and thank you for taking my questions. I guess my first question is about the non-COVID 19 excess mortality in the US. Can you provide some color in terms of maybe the age cohorts on average claim size or maybe the cost of that based on your analysis.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah, Humphrey, it's Jonathan. I'll take that. So our yields mortality experience this quarter is really driven by broad based higher frequency of claims and that's due to COVID and non-COVID, so the whole piece. There is no notable patterns by issue your cohorts or policy size or clients. Consistent with general population data, we are seeing an overall increase in excess mortality at ages less than 65, which is really a change that we've highlighted from earlier in the pandemic. For the average claim size added at the -- sorry, aggregate level across US mortality is actually relatively stable quarter-to-quarter. But as I mentioned earlier, the COVID specific claim size has increased.\n\nHumphrey Lee -- Dowling and Partners -- Analyst\n\nGot it. My second question is more about India and South Africa. How much did you normally earn in India and South Africa before the pandemic? Just kind of looking at data claims so far by my count, the COVID claims from these two countries have been roughly 400 million since the pandemic, pretty much kind of one-third of the claims that you've seen in the US. And looking at the mortality amount of risk disclosure that you provided in the first quarter '20 DAC, they can be more than low single digit percentage points. So can you just help us to kind of get a better perspective of be exposure for this country and how the size of those claims could be relatively large compared to the -- your exposure there?\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah, see I'll talk about the exposure from a net amount of risk perspective, Humphrey. So India represents about 5% of our global net amount of risk. South Africa is between 1% and 2% of our net amount of risk just to give you a sense of the scale. As you mentioned the COVID claims experience has been material in both of those markets, I guess you could say disproportionate to the actual net amount of risk exposure we have, that's really a function of the underlying general population mortality experience that we're seeing. We also routinely obviously discuss with clients what's happening in those markets, and what we're seeing in South Africa as an example is consistent with what our clients are seeing. So again it's the impacts we're seeing from COVID is really a reflection of what's happening in the general population.\n\nHumphrey Lee -- Dowling and Partners -- Analyst\n\nOkay, all right, thanks.\n\nOperator\n\nWe will move on to our next question from Andrew Kligerman of Credit Suisse. Please go ahead, your line is open.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nHey, good morning. Maybe to start off on capital management, you indicate a $1 billion of excess capital. Given the sharp losses this quarter, maybe a little color on your outlook for share repurchases and any other uses of capital, but could you keep to buyback going?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nHey, Andrew. it's Todd.\n\nAnna Manning -- President and Chief Executive Officer\n\nApologies, Todd. Maybe I can start and then ask you to add. Andrew, we're on a long-term business and supporting clients whether on their organic needs are block deals, that's really core to our strategy. So when we think about capital management, we start there. We start by looking at new business opportunities in the pipelines and how we feel about those opportunities and then the likelihood of winning and what are the return levels we think we can get. And remember, some of our deals do take time to complete. We then weigh that against all the alternatives, returning capital through buybacks, through dividends, really looking for the best and most valuable use of our excess capital. That's how we'll approach capital management in the past, it's produced a nice balance. We expect to go back there. And in my mind this quarter doesn't change that. Todd, would you like to add?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nNo, I think that covers the thing, Anna.\n\nAnna Manning -- President and Chief Executive Officer\n\nOkay.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nAnd just I actually have one more major question I think. This is in a side related to that. $94 million of asset intensive retrocession, so you you raised $94 million of capital, maybe a little color on why that was done?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nYeah. Andrew, it's Todd. So this is a transaction that we [Indecipherable] the inbound transaction we've entered into fairly recently and we like the overall characteristics of the block that we were able to find financially attractive retrocession terms that actually help enhance our returns overall on the block, which we thought was very attractive. And when we retrocede part of that asset intensive block it freed up some of the capital that we had against the block.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nOkay. And then just with regard to premium, I mean, US looked really good. You mentioned a onetime restructuring of an existing tree -- I wasn't sure what the normalized number would be in the US ex that restructure and what did it relate to? And with that, why were the premium so strong? That's terrific. I mean, Canada, EMEA, they all looked great in terms of growth, but US in particular why strong?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nYes, so the first part of your question, yes, we had a transaction that had been in place for a little bit of time in the US and Latin America segment. That converted from what we call sort of low-risk or deposit accounting to where we took more of the biometrics risk and under GAAP accounting it turned in -- translated into risk accounting where you recognize the premiums and benefits and that type of thing on the income statement. So that added to the premium growth in the US and Latin America segment. If you back that out, I think the growth in the US is probably between 4% and 5%.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nOkay. So more normalized.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nYes, yes.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nAnd in Canada? In Canada and the EU [Indecipherable] really strong, anything driving that?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nNo, no -- So Canada did some transactions and saw good business growth. And then really for EMEA, it was across the region, which was good to see just a lot of good activity.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nThanks a lot.\n\nAnna Manning -- President and Chief Executive Officer\n\nI would add, Andrew. Yeah. Andrew, I would add that reflecting what I believe to be, or reflecting our approach during the pandemic which was we stayed close to our clients. We provided a lot of thought leadership throughout the pandemic, underwriting expertise, and I think part of that is translating into business activities that we're seeing.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nThanks so much.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nAnd today [Phonetic] maybe add-ons details point is in for Canada EMEA, there was some positive FX contribution to the reported premium growth.\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nAlright. Saw that in the release. Thanks.\n\nOperator\n\nWe will move on to our next question from Erik Bass of Autonomous Research. Please go ahead, your line is open.\n\nErik Bass -- Autonomous Research -- Analyst\n\nHi, thank you. And for the US traditional block, can you give some more color on the age and product breakdown of your mortality book and where the COVID impacts occurred this quarter? I guess I'm trying to get a sense of why your sensitivity this quarter looks different from what we've seen from a lot of the primary companies and even the other reinsurers and where they are seeing less COVID losses in Individual Life as the percentage of population deaths if mortality moves to younger ages.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah, this is Jonathan, Erik. So, yes, so we have the largest proportion of our business would be in sort of that middle age range. So what I mean is sort of that 40 to 65 range. So that is a larger proportion of our business relative to the older ages where we're seeing the early impacts from the pandemic. So I think that shift down below 65 is part of the impact there. Also, we tend to have larger policy sizes as well when you move down those age ranges, which I think is partly what's driving some of the increase in size.\n\nErik Bass -- Autonomous Research -- Analyst\n\nOkay.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\n[Indecipherable] term block where you may have sort of higher face values or where you're taking kind of excess amounts above -- so the primary companies are seating kind of excess risk to you.\n\nAnna Manning -- President and Chief Executive Officer\n\nHi, Eirk, I don't think that's necessarily the case. I think the thing to remember when you're comparing our sensitivities or our rules of thumbs against others is that the size of the block matters because we're all using per 10,000 deaths in the population. So you would expect that if you're comparing a sensitivity from one firm to another, if there is double and triple the size of the block of business we would expect to see that in the resulting sensitivities.\n\nErik Bass -- Autonomous Research -- Analyst\n\nGot it. No, I was looking at relative to -- in ranges where others were coming in sort of at the lower end of the ranges versus yours slightly above the high end. So not the absolute number, but the relative.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\n[Technical Issues] just one more thing to keep in mind too is that we do think there is potentially some quarterly volatility here as well. So it's hard to draw conclusions from based on one quarter's information, just kind of an immediate -- something that's occurred recently in Q2 we actually saw quite a low level relative to our range. So they can move around quarter-to-quarter. So that's why we want to see some more data emerge before you consider making a change to our range.\n\nErik Bass -- Autonomous Research -- Analyst\n\nGot it. Thank you. And if I could just ask one follow-up on the India business. How much of a reporting lag are you seeing in that business? It looked like the population deaths were actually lower in 3Q than 2Q. So it was a lot of this kind of a catch up on kind of deaths that actually occurred in earlier periods?\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah. Yeah, no, it's exactly right. So of the $161 million charge that we took this quarter, the majority of it, so around $138 million or so relates to Q2 experience. So due to these longer reporting lags we did establish an expectation in IBNR last quarter, but really that was done pre Delta wave. All right. So we were going on information that we had based on what we had experienced in India, as you recall, is really the first country to have a material delta wave impact. So that's really what's causing the difference now. So we're seeing the delta wave move into younger ages, higher policy size amounts. So most of what we're seeing this quarter relates to last quarter.\n\nErik Bass -- Autonomous Research -- Analyst\n\nGot it. Thank you.\n\nOperator\n\nWe'll move on to our next question from John Barnidge of Piper Sandler. Please go ahead, your line is open.\n\nJohn Barnidge -- Piper Sandler -- Analyst\n\nThank you very much, and good morning. The Chief Operating Officer left, was there a charge in the quarter or is that going to occur in 4Q?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nThere is. Hi, John, it's Todd. There was nothing in in 3Q and I -- as of right now, I'm not expecting anything material in the fourth quarter.\n\nJohn Barnidge -- Piper Sandler -- Analyst\n\nOkay. And then my follow-up question, maybe asking the buyback question a little bit differently. Can you talk about how the cadence of those buybacks changed as the quarter went along in the delta variant emerged? Thanks for the answer.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nNo we -- on the buybacks, we wanted to -- so our confidence in the business and the value proposition of our enterprise, so we decided to go ahead and take repurchased some shares. And I'm trying to think back of the exact timing, but it wasn't a huge consideration related to the COVID impact, but was before this significant, I guess, impact that we saw -- do about how significant the impact was.\n\nJohn Barnidge -- Piper Sandler -- Analyst\n\nThank you.\n\nOperator\n\nWe will move on to our next question from Ryan Krueger of KBW. Please go ahead, your line is open.\n\nRyan Krueger -- KBW -- Analyst\n\nHi, good morning. Back to the US COVID impacts. Could you help us understand a little -- in a little bit more detail how material the impact was from the higher average claim size versus just the higher incidents?\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYes. So just to give you a number, so this quarter our average COVID claim was about 22% higher than what it has been for the first two quarters of the year or the -- through the prior waves.\n\nRyan Krueger -- KBW -- Analyst\n\nThat's helpful. And I mean I guess at this point, is there any reason to think that wouldn't continue given the shift in -- to the younger ages. And I guess what I'm getting at is the only reason you're not changing your sensitivity because you want to see more data and increased credibility but [Indecipherable] through it there wouldn't be much reason to think higher severity issue would really change if the age mix continues as it did in the third quarter.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah, I think it's too early to draw that conclusion for certain. It's possible we could continue to see higher average claim size and the shift to younger ages. As I mentioned earlier, it does vary a lot quarter to quarter. And the prior quarter, which also we're showing some increase in COVID mortality into the younger ages, actually was our lowest average claims size quarter for COVID that we've had over the course of the pandemic. So I think it is too early to to determine how much of this of will persist or not. And as we get more data over the course of this quarter, we'll evaluate that if we need to update our range.\n\nRyan Krueger -- KBW -- Analyst\n\nThanks. And then on block deals you've been pretty active this year for -- but can you also comment on Langhorne and activity you might be seeing there at this point.\n\nAnna Manning -- President and Chief Executive Officer\n\nYeah, let me take that one. So first, let me start with your Langhorne questions, then perhaps follow I can provide some color on our deals. We're remaining active at Langhorne. It's one of our top priorities. we have dedicated resources that are actively at work on deals and I remain optimistic about getting one across the line, getting more than one across the line. On the Q3 deals, very pleased with the quarter's deals as Todd mentioned $140 million of capital. And if you add the $300 million in the first quarter, that brings us to $440 million for the three quarters. That puts us on track for a very strong year especially given the state of the pipelines. I was pleased with the distribution of the deals. We did life deal in Asia, one in the U.K. and then an AIG Asset Intensive deals in EMEA. And overall, I'm very happy with the deal and optimistic on the pipelines.\n\nRyan Krueger -- KBW -- Analyst\n\nThank you.\n\nOperator\n\nWe'll move on to our next question from Michael Ward of UBS, please go ahead, your line is open.\n\nMichael Ward -- UBS -- Analyst\n\nThanks guys, good morning. Maybe to expand on the buyback cadence question, so you said the buyback decision Todd was before you realized how kind of bad the COVID impact would be. So I guess, does that mean we should think you'll be more conscious going forward. And have you bought back any shares in 4Q to-date?\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nNo, the way I would look at it is we have -- we continue to have a strong balance sheet and we feel we can be prudent and balanced around our overall capital management. Certainly, we're going to keep an eye on what's unfolding with the the pandemic, but certainly as Anna mentioned earlier, we'll look at deploying capital in the transactions where we like the liability profile and we can get attractive returns. And we'll continue to look at the dividend and share repurchases. We'll continue that sort of a balanced and prudent approach as we go forward.\n\nMichael Ward -- UBS -- Analyst\n\nOkay. And then regarding the annuity retrocession deal, you said it was inbound. But can we think about this as maybe the first of more to come, or should we be thinking about RGA as potentially in maybe the de-risking bucket and are there other areas in life for annuities or you could do more of this, free up capital and give us maybe a new reason to look at RGA. Thanks.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nYou want to mention the inbound transaction that was -- it was the inbound transaction to RGA and then we rent for a portion of that to a third party. I would not view it -- the retrocession that we did as de-risking. It was more we were able -- from an economic perspective, it was an attractive transaction for us to do and it enhanced our overall returns while providing some capital flexibility. And certainly it's something, as we've mentioned in the past, we are looking at our -- there is capital management tool kit items that we can have access to and retrocession at what we would view as favorable economic terms is certainly one of those things that we'll keep in mind over time.\n\nAnna Manning -- President and Chief Executive Officer\n\nAnd I'd like to emphasize the motivation for that transaction was not to de-risk. It was a opportunistic transaction, very attractive financially and it happened to generate $100 million in capital.\n\nMichael Ward -- UBS -- Analyst\n\nThank you.\n\nOperator\n\nWe'll move onto our next question from Tom Gallagher of Evercore ASI -- ISI. Please go ahead, your line is open.\n\nTom Gallagher -- Evercore ISI -- Analyst\n\nThank you. I guess my first question is, has the emerging experience caused you to push through any rate or are you contemplating pushing through any rate whether that's in the US or some of these international markets where particularly India, South Africa. I'm assuming the loss ratios might be 500%, 1000%, we don't know how much premium you're charging. Because there's obviously a lot of uncertainty with where the pandemic is going to go, but you probably have some scenarios where the loss emergence here could really pressure the -- what the combined ratio would be in these businesses for the next year or two. So just curious, overall how are you thinking about that and are you planning on pushing through rate where you can in either US or some of these other markets.\n\nAnna Manning -- President and Chief Executive Officer\n\nI'll start with --\n\nOperator\n\nOh, sorry. Please go ahead.\n\nAnna Manning -- President and Chief Executive Officer\n\nI know it's difficult as these virtual calls is well how to remove, stay in room. Go ahead. Jonathan, I'll add to -- I'll add my comments at the end.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nOkay. Yeah, thanks. Yes. So I mean, I guess, I would just say, first, we are taking action and have been for quite some time to reflect our expectations for COVID and the pricing of new business that we're writing. That's the first thing I would note. We're also being cautious in markets where we think there is more risk. So that relates to how we're evaluating new business, volumes in new business that we're choosing to accept types of business we're choosing to accept. And we're also applying a thoughtful approach on our underwriting as well. So again, just to manage the risk exposure. So while we do have open treaties and this is [Technical Issues] place globally, not just in any one market, we're working with our clients very closely. We're adjusting underwriting rules and taking new data into account as we assess the risks. Anna?\n\nAnna Manning -- President and Chief Executive Officer\n\nTodd, thank you, you've covered it.\n\nTom Gallagher -- Evercore ISI -- Analyst\n\nSo -- and I appreciate that, and that's just on new business, so you're not repricing existing treaties for this emerging experience at all.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nYeah, I mean, certainly where we have the opportunity to do that, it's being considered. So for group business as an example, which is annually renewable generally speaking, that absolutely is being repriced and taken into account the COVID expectations. For longer-term business I think you have to think of that business in more of a longer-term context as well and obviously you know we have an approach where we consider not just the current period but future periods and what our overall balance of our relationships with our clients and we take all of that into account when we consider actions on the long-term business.\n\nTom Gallagher -- Evercore ISI -- Analyst\n\nGot you. And I guess the other -- the next question is sort of enterprise risk management too. Do you -- now obviously this experience, I think most people are viewing this whole emerging experience like a catastrophe that's lasted a year and a half is essentially and not likely to recur hopefully much beyond the current timeframe. But does it cause you to rethink enterprise risk management at all? Like, do you think now given this experience kind of the variant that have occurred, does that cause you to rethink how you're thinking about risk management overall, meaning, is there some permanent change in loss ratio you think that needs to be factored in. And maybe it's the -- maybe set in a better way, is the tail risk here now a lot higher than you would have previously thought that could sort of be sustained higher losses. And if so, how does that kind of inform your view on either exposure risk management or pricing. So kind of a high-level question, but just curious how you're looking at this whole experience.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah, yeah. I know and I think a hallmark of a good risk management process and hopefully we can put ourselves in that bucket, is really looking at lessons learned, right? So after you go through an event like this we're analyzing what the impacts were and making adjustments in the future. So we're not -- that work is ongoing and really always always happening when we analyze and look at our business. So things like our process over the last two decades to diversify our book of business, I think has been part of that thinking around risk management. And I think we'll continue to be an element of what we think about right as far as our having a solid mix of risks across the enterprise, which has proven itself I think going to last six quarters, that's been very helpful position to be in. Things like you mentioned about tail risk and capital models, those are elements that we're considering as well. I think our capital model even with these impacts we've had so far has proven out to be conservative in what our expectations were for a pandemic event. But I think you need to look at the data that's emerging, you need to consider what that means and obviously that will push then into pricing, to risk management [Technical Issues] And so I think it is a work in progress, but I think everything you mentioned are things we're thinking about as well.\n\nMichael Ward -- UBS -- Analyst\n\nGot you. And then just final question if I could on that same topic. Any changes you're considering over the near term, whether that's limiting risk to some of these markets that have had very high loss ratios, India, South Africa, etc., whether it's utilization of retrocession or cutting the size or any risk mitigants that you're thinking about over the near term, or are you still going to wait to evaluate more experience.\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nYeah, I know I. I mean, I think I'll point out again the -- what we've already done, right? So this is something that we in fact been taking active positions on since the start of the pandemic really and it goes into what you were saying about managing volumes, managing type of business that we're accepting, changing prices. So all of those things have been things we've been active to do over the course of the pandemic and we'll continue to do.\n\nTom Gallagher -- Evercore ISI -- Analyst\n\nOkay, thank you.\n\nOperator\n\nWe'll move on to our next question from James Inglis. Please go ahead, your line is open.\n\nJames Inglis -- Analyst\n\nHi, good morning. I'm talking -- I'm thinking about your ability to generate capital through the retrocessional transaction, and presumably that is because there is a capital provider who is willing to take a lower return than you folks would, which is good. But I'm just trying to draw contrast if there is, are there any parallels to be made with the ability or the availability of capital in the world, if you will, as opposed to your ability to get deals done in Langhorne, I mean, it seems to me there's got to be some parallel there and correct me if I'm wrong.\n\nAnna Manning -- President and Chief Executive Officer\n\nCould you reframe your question because I'm not sure I'm connecting the retrocession transaction which again was not motivated by capital to your question about capital.\n\nJames Inglis -- Analyst\n\nNo, you're correct, in which -- and I wasn't making analogy that it was motivated by capital but it was -- I was trying to make an analogy it was motivated by other capital providers interest in getting return on that and that book of business and how that must be limiting the fact that there is that capital available out there must be limiting your ability to do deals in Langhorne.\n\nAnna Manning -- President and Chief Executive Officer\n\nOh, now I see the connection that you're drawing. Yes, there is a lot of competition out there. And there are a lot of capital providers who are interested in the type of transactions that -- well, the transaction in particular that we did, the retrocession transactions. Look, I think price is a factor in doing deals, but it's not the only factor. We don't just compete on price. We compete on a broader value proposition, and that's around expertise. Our risk expertise and our structuring expertise and in particular our appetite to take insurance, life insurance biometrics risk as opposed to the asset type of deals, which I think is generally where those new capital providers are focused. So yes, price is a factor, but it's not the only factor. I remain optimistic about getting deals done in Langhorne.\n\nJames Inglis -- Analyst\n\nOkay, great. Thank you. Good luck.\n\nOperator\n\nWe'll take our next question from Michael Ward UBS, please go ahead, your line is open.\n\nMichael Ward -- UBS -- Analyst\n\nHey, guys. Thank you for the follow-up. My question already from Langhorne, my question around the retrocession I wasn't implying that delisting is a negative thing, I think if anything it's a positive. You know, we've been seeing life companies do this especially over the last year or two. And even just talking about having a plan to monetize certain assets or blocks that are maybe more capital intensive and whatnot. It's been a clear positive for those companies or at least our stock. So, my question was more along the lines of, do you want to do more of this? I know this was a sort of opportunistic deals, but I'm wondering if this is something that you want to do more of. Thanks.\n\nAnna Manning -- President and Chief Executive Officer\n\nRight. Thank you for that -- thank you for that follow-up question. We're open to consider -- to considering a future transactions where it makes sense for us. And as we've already mentioned, this was a nice transaction and it fit in many respects. It isn't something that's new for us, we've done retrocessions and securitizations in the past, and I expect we'll continue to do them as market conditions, as opportunities arise, as the economics makes sense for us. It's another tool in our toolkit.\n\nMichael Ward -- UBS -- Analyst\n\nThank you.\n\nOperator\n\nAnd it appears we have no further questions over the audio, I'd like to turn the conference back for any additional or closing remarks.\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nOkay, thank you. I thank everybody for joining the call this morning and your continued interest in RGA, and we look forward to seeing you in December at our Investor Day.\n\nOperator\n\n[Operator Closing Remarks]\n\nDuration: 51 minutes\n\nTodd C. Larson -- Senior Executive Vice President and Chief Financial Officer\n\nAnna Manning -- President and Chief Executive Officer\n\nJonathan Porter -- Executive Vice President, Global Chief Risk Officer\n\nHumphrey Lee -- Dowling and Partners -- Analyst\n\nAndrew Kligerman -- Credit Suisse -- Analyst\n\nErik Bass -- Autonomous Research -- Analyst\n\nJohn Barnidge -- Piper Sandler -- Analyst\n\nRyan Krueger -- KBW -- Analyst\n\nMichael Ward -- UBS -- Analyst\n\nTom Gallagher -- Evercore ISI -- Analyst\n\nJames Inglis -- Analyst\n\nMore RGA analysis\n\nAll earnings call transcripts\n\n"}
{"id": "0070c69c-2f86-486e-beba-8583b6314bf0", "companyName": "Shift4 Payments, Inc.", "companyTicker": "FOUR", "quarter": 2, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/05/shift4-payments-inc-four-q2-2022-earnings-call-tra/", "content": "Shift4 Payments, Inc.\u00a0(FOUR 4.15%)\nQ2\u00a02022 Earnings Call\nAug 04, 2022, 8:30 a.m. ET\n\nOperator\n\nHello, and welcome to the Shift4 second quarter earnings call. My name is Alex, and I'll be coordinating the call today. [Operator instructions] I will now hand over to your host, Tom McCrohan, head of investor relations. Tom, over to you.\n\nTom McCrohan -- Head of Investor Relations\n\nThank you, Alex, and good morning, everyone, and welcome to Shift4 second quarter earnings conference call. With me on the call today are Jared Isaacman, Shift4's founder and chief executive officer, Taylor Lauber, our president and chief strategy officer, and Nancy Disman. This call is being webcast on the investor relations section of our website, which can be found at investors.shift4.com. Our quarterly shareholder letter containing quarterly financial results has also been posted to our IR website.\n\nOur call and earnings materials today include forward-looking statements. These statements are not guarantees of future performance, and our actual results could differ materially as a result of many important factors. Additional information concerning those factors is available in our most recent reports on Forms 10-K and 10-Q, which you can find on the SEC's website and the investor relations section of our corporate website. For any non-GAAP financial information discussed on this call, the related GAAP measures and reconciliations are available in today's quarterly shareholder letter.\n\nWith that, let me turn the call over to Jared. Jared?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nThanks, Tom, and good morning, everyone. So we have lots to cover today. As you may have seen from an 8-K filed last night, Brad Herring, our chief financial officer, is pursuing other opportunities. We're really grateful for the time and effort Brad has contributed to Shift4.\n\nSince his joining the company in 2019, we've gone public on the New York Stock Exchange. We've diversified into six new verticals. We completed several acquisitions and grown our end-to-end payment volume over 200% and all with the backdrop of a global pandemic. So Brad played a key role in all this, and we're sincerely thank him for his service.\n\nAs of tomorrow, Brad will be succeeded by Nancy Disman, who is both a phenomenal industry executive and a good friend to ship for. Nancy most recently served on our board of directors from which she has resigned effective as of tomorrow. She is also recently the CFO and CAO of Intrado. Prior to Intrado, Nancy served as the CFO and CAO of TSYS merchant services following TSYS' acquisition of TransFirst, where she also served as CFO.\n\nNancy has also held executive roles at Cynergy Data Corporation and First Data Corporation, and we're really excited to continue working with Nancy in her new role. So now for the quarterly update, as mentioned in my letter, we are really pleased with our results this quarter, including the progress we are making in all our new verticals, although our high-growth core continues to be the primary contributor of our overall performance. For the second quarter, we generated 43% year-over-year growth in our end-to-end payment volume and 34% year-over-year growth in our gross revenue less network fees. We continue to gain market share across our high-growth core growing from net new wins and gateway conversions.\n\nAnd now with our new verticals beginning to ramp meaningfully, we believe we are positioned to deliver consistent profitable growth even as we continue our expansion into new verticals and new geographic markets in the months and years ahead. As in the past, I will focus my comments initially on our high-growth core then speak to our new markets and verticals. But before getting into the components of our business, I want to highlight our current thoughts about the overall economy and its potential impact to our business. In short, we have not yet witnessed a material impact on our overall volumes from changes in consumer behavior.\n\nOur four-year volume CAGR improved from last quarter, and our monthly volume trends continue to improve as we approach the seasonally stronger summer months. Having said that, we're also realists. We are aware that persistent inflation headwinds could ultimately influence consumer behavior, and this could result in consumers pulling back on some discretionary spending. We are fortunate to have invested in our new verticals, as well as specific levers that are less impacted by economic cycles.\n\nIn short, we believe that we are prepared to manage our business through all economic cycles, just like we have done over the last 23 years, and we intend to continue growing revenue and volume every year through the best and most challenging of economic times. To this end, we are leaving our end-to-end volume guidance unchanged for this year while increasing our gross revenue less network fees, increasing adjusted EBITDA and increasing adjusted free cash flow guidance. While we cannot predict consumer behavior in this uncertain environment, we have witnessed early success in our gateway sunset strategy, which gives us confidence in our ability to drive incremental revenue and EBITDA above our prior expectations. Our conversations with our gateway-only customers are very encouraging.\n\nAnd we view our decision to leave volume unchanged but increasing revenue and adjusted EBITDA guidance as a balanced approach to take during these uncertain times. I want to emphasize our belief that unlike some of our peers, we are not completely at the mercy of the broader economy. Our gateway and software-only merchants provide a highly unique asset and that we can grow exponentially without even adding a new customer. I'm going to focus the remainder of my comments on the performance of our high-growth core and then an update on our new markets and verticals.\n\nSo with respect to high-growth core, as you can see this quarter, the primary driver of our performance does remain high growth. The high-growth core represents the payment opportunities we pursue primarily in complex restaurants, hospitality and specialty retailers. And as many of you already know, Shift4 has been growing at accelerated rates in this arena by leveraging our unique software integrations and pain point solving technology. We currently have over 450 now unique software integrations, and we continue to win shares through a combination of migrating merchants off our gateway platform to our end-to-end service, as well as just net new wins in what is a very large addressable market.\n\nOur growing library of software integrations results in more links in the value chain to deliver a lower effective cost of service to our customers. Said differently, we are able to offer our customers more capabilities at a lower cost because they no longer need to depend on a multitude of other costly vendors to attempt to achieve a comparable solution. Throughout the quarter, we signed a number of new resort properties and high-end restaurants, including the soon to be opened Nobu Hotel in Atlanta, the New Orleans-based Hotel Monteleone, The Langham hotel in Chicago, Manhattan's Gansevoort Hotel, and Feld Entertainment, which operates Disney on Ice, Monster Jam, Ringling Brothers, and Sesame Street Live!, among others. As a result, during the second quarter, we again organically grew our end-to-end payment volumes faster than any of our peers and faster than Visa and Mastercard.\n\nOne proof point would be our nearly 42% 4-year volume CAGR, including 52% volume CAGR in restaurants and 170% volume CAGR in lodging. As a reminder, this four-year volume CAGR occurred during an unprecedented pandemic when our end markets have been quite impacted. For the quarter, our volume growth is 307% of prepandemic 2019 levels along with gross revenue less network fees at 243% and adjusted EBITDA at 272% over the same period. It's worthwhile calling out that this growth took place without the benefit of our new markets and verticals, which are now just beginning to ramp.\n\nAs discussed in the prior quarters, we have just begun removing complexity, the leading parts and increasing organizational efficiencies by executing on our gateway sunset initiative and are very confident in our ability to successfully convert gateway-only merchants to our end-to-end platform or get paid more in line with the value our payment technology provides. While it's really early, the results are very promising, and Taylor is going to go into that in just a few minutes. I did want to highlight a case study on the Gateway Sunset strategy that I believe is emblematic of why we are so confident in this approach. During the quarter, we signed a world-renowned motorcycle franchise that we had historically been unsuccessful converting to our end-to-end platform.\n\nWe had been soliciting this merchant for nearly five years. And despite our efforts, it was ultimately our gateway sunset initiative that entice this merchant to engage with us to discuss the merits of switching to our end-to-end platform. We are in the process of migrating this motorcycle franchise to our platform. And we are having hundreds of similar conversations with other gateway-only customers.\n\nSo I cannot be more excited about the pipeline. The gateway sunset initiative is the right strategy at the right time and for all the right reasons. While contribution from our gateway sunset initiative was minimal this quarter, we're highly confident the initiative will result in us getting paid fairly regardless of clients pay us more to remain gateway-only or elect to convert to our end-to-end platform. We expect that it will contribute incremental adjusted EBITDA and adjusted free cash flow and is one of the factors driving our increase to our full year guidance.\n\nIn restaurants, we reached an agreement with enterprise operator, BJ's Restaurant and Brewhouse, a Southern California headquartered national restaurant chain with over 200 restaurants in 29 states. We signed a multiyear agreement with BJ's to provide POS, software as a service for all their restaurants across the U.S. We also reached a similar agreement with one of the world's largest restaurant groups. These opportunities represent a meaningful recurring revenue and EBITDA contribution that we expect to be realized more toward the latter part of '22 and into 2023.\n\nThis represents the first of several notable restaurant opportunities we are in discussions with on our restaurant POS offering. Moving to SkyTab POS. I would like to update you on the progress of our next-generation POS product that will serve the restaurant market. Restaurants remain a key market for us, and that is why we have invested over the last few years in a new cloud-based restaurant POS offering called SkyTab.\n\nWe are getting ready to release SkyTab POS from beta at the end of this month, and it's already installed in thousands of locations. SkyTab is not just designed for restaurants as we are also having early success in selling SkyTab at theme parks and resorts. We also intend to bring this product into international markets. Recall, we are uniquely advantaged to pursue over 125,000 restaurants that are already customers using some form of Shift4 technology and many of them are not on our end-to-end platform and even less are paying any SaaS charges.\n\nWe expect that SkyTab POS will represent the migration path for this existing base of restaurants many of whom are seeking out new capabilities to better serve their patrons in addition to the large addressable market of just new restaurants. SkyTab services the mid- to high-end restaurant customer based on a cloud-based Android technology stack built from the ground up and equipped with very modern and purpose-built space age hardware. We have been going to market with SkyTab through our historic third-party distribution channels but have recently begun pivoting toward direct sales in the same way we go to market in many of our new verticals. We have found some initial successes selectively in-sourcing some of our third-party distribution partners in the most desirable markets as the opportunity to insource distribution becomes an increasingly viable with a cloud-based solution.\n\nWe believe we can improve the customer experience alongside margins without compromising the same high-touch support our customers have grown accustomed to receiving. So to summarize our high-growth core, we are excited about the combination of our accelerated gateway conversion plan, the launch of our new SkyTab POS offering and the momentum are high-growth core supported by our unique integrations with over 450 mission-critical software suites. All of this gives us confidence in our outlook and supports our decision to increase our gross revenue less network fees, our adjusted EBITDA and adjusted free cash flow guidance for the full year. So moving on to new verticals.\n\nAs I mentioned previously, our impressive volume growth has been without significant benefit from our new verticals. For clarity, we consider our new verticals to be sports and entertainment, gaming, travel, nonprofit and what we refer to as just sexy tech. This should not be surprising. It should be challenging to get the attention of software companies and enterprise merchants to complete a payment integration.\n\nWe often see that software companies and merchants tend to want to invest their time in anything, but additional payment integration, which is why they become so valuable once you've achieved it. We are really pleased with the progress we made in the second quarter, though much of the progress was literally made in the last week of June when the Starlink integration went live. So while our new verticals contributed throughout the year and into June, they've only really begun to scale meaningfully in July, and Allegiant Airlines is not expected to go live until late August. So we added a chart on page eight of our quarterly shareholder letter, depicting the year-to-date ramp in monthly volumes for our new markets and while it has taken a bit longer for our new verticals to contribute to our volumes, we feel really good about how that ramp is progressing, the contributions they can make in the second half of the year and how these strategic relationships and verticals aligned with our global expansion aspirations.\n\nTo emphasize these points, we do expect to see a much stronger contribution from these verticals as the year progresses. For example, we're in the process of implementing a number of large NCAA and NFL stadium clients in time for this football season. We're adding more states and capturing more volume from BetMGM and turning on more integrations from our nonprofit customers, and we're more than halfway through the Allegiant Airlines integration, and of course, Starlink volumes are on an impressive trajectory as they continue to populate their satellite constellation. I am biased, but I believe that we have never had a merchant in our history that is ramping as quickly or has so much upside at Starlink.\n\nIn gaming, we continue to add new commercial and tribal gaming supplier licenses and BetMGM volume has more than tripled since our last earnings call in May. We continue to build upon our early success with BetMGM and added several states this past week alone. As a result, we expect to see a further significant and sustainable spike in volume before the end of the third quarter, given the seasonally strong sports wagering tied to the football season. In nonprofits, we began processing for St.\n\nJude's in January of this year and overall volume continues to ramp. With our acquisition of The Giving Block, we've seen impressive results across multiple KPIs that Taylor will talk through in just a minute. Given the nature of nonprofits, we do expect the fourth quarter to represent the peak season for donation volume. We are scheduled to complete an integration of Allegiant Airlines by September 1, and we have signed a European travel agency Kiwi.com as a customer and expect to begin processing shortly as well.\n\nTurning back to stadiums. We signed a number of new professional and college sports stadiums, including the University of Alabama, University of Wisconsin, University of Notre Dame and professional sports teams, including the New Orleans Saints and Pelicans where we also provide ticketing. Our VenueNext mobile commerce technology is the category leader in sports and entertainment venues and our software is now installed in well over 100 stadiums in the U.S. Our new business pipeline in this space remains very strong, including international stadium discussions.\n\nPerhaps the most important competitive win this quarter came from sports-focused retailer fanatics. We will process all of Fanatics in-venue payment processing at approximately 50 sporting and entertainment venues, including PGA Tour events and NASCAR races. As a leading manufacturer and distributor of sports-related merchandise, Fanatics will be a tremendous partner as we mutually expand our footprint in the sports and entertainment space. Our performance across these new verticals, alongside our stated international expansion plans, has attracted the interest of many notable customers.\n\nSome are in the negotiation phase. Others we have won and, in some cases, we're not permitted to announce publicly. And in others, like Fanatics and time, we have recently selected Shift4 to power their payment strategies. It's worth reinforcing that Shift4 wins because of our ability to solve our clients' problems.\n\nMerchants are not switching to Shift4 to save a basis point or pennies per transaction even though in our experience, they usually benefit from an overall lower effective cost of service. Instead, they switch because we offer complete commerce solutions that enable them to better engage with their customers and patrons such as QR codes, online ordering, mobile and contactless payments, business intelligence and more. This is why despite our continued move upmarket, our net spreads have remained stable over a multiyear period. And our move upmarket has been at an unprecedented pace we have effectively doubled the size of our average merchant since 2019.\n\nSo before passing things off to Taylor, I wanted to provide you with an update on our recently completed acquisition of The Giving Block and the pending acquisition of Finaro. The Giving Blocks crypto donation platform continues to sign up new nonprofit customers despite the drop in value in most in crypto assets. As I write this, the single Bitcoin is still valued at over $20,000 and nonprofits are still interested in accepting cryptocurrencies such as Bitcoin. Since we closed the deal back in March, The Giving Block has signed up over 400 new nonprofit customers including the world's largest humanitarian organization, the World Food Programme, as well as many other highlighted in our quarterly shareholder letter.\n\nThe Giving Block has introduced a card widget for nonprofit so they can accept traditional card-based donations and the growth in their client base has resulted in a nearly sixfold increase in their SaaS revenues versus a year ago. The team continues to execute on a significant $45 billion cross-sell opportunity and successfully converted several giving block customers to our end-to-end platform. We believe our go-to-market offering remains unique in the nonprofit sector and remain highly attractive to what we view as a $450 billion payment opportunity where we now have a unique right to win. While on the subject of The Giving Block, I would like to personally thank those of you that participated in our carrying with crypto fundraising campaign.\n\nWe launched this fundraiser in mid-March to raise awareness within the crypto community, and I agreed to personally match dollar for dollar every crypto donation made on the giving block marketplace up to $10 million. Parts of this fundraising campaign are still underway, and I encourage all of you to check out thegivingblock.com website for more information. We are also making progress receiving all the necessary European regulatory approvals to close on our acquisition of Finaro later this year. As a reminder, we announced the acquisition of Finaro back in March in conjunction with our year-end results.\n\nAnd for those unfamiliar, Finaro is a European cross-border e-commerce platform with processing capabilities and licenses in Europe and parts of APAC. The two sides -- the two of us are making great progress connecting the payment platform via arm's length partnerships during the regulatory review period, and we have successfully tested transactions between the U.S. and Europe. We intentionally structured the earnout portion of this transaction to encourage both sides to pursue commercial opportunities up until closing, and the teams are working together nicely on a number of initiatives.\n\nFor example, we are beginning to refer each other merchants. Finaro services, many e-commerce merchants in Europe that also have U.S. operations supported by U.S. payment processor.\n\nI'm pleased to announce that Denmark-based online sporting goods retailer, Skatepro as one of the first wins alongside Kiwi.com. Skatepro is an e-commerce customer of Finaro, who relied on Finaro for their European e-commerce processing, but outsource their U.S. payment processing to a U.S. competitor.\n\nGoing forward, Skatepro will switch the U.S. payment processing to Shift4, effectively consolidating all their global e-commerce payment processing business into a Shift4 Finaro solution. There are many other merchants we are currently in discussion with regarding a joint U.S./EU offering and are pleased that our planned acquisition is yielding synergies in advance of the planned closing date. We do retain significant firepower to pursue additional acquisitions and remain focused on building out our global technology capabilities in the markets to support our signature multinational customer.\n\nWe have a low pro forma leverage ratio and a ton of conviction around our strategic plan. Internally, we remain very focused on operational improvements to make us a much more efficient company consistent with the Shift4 way. This includes investments we have made in our payment platform that have delivered 100% uptime during the quarter despite immense growth and something few of our competitors were able to achieve over a comparable time period. In addition to the executive transition mentioned at the outset of the call, this past quarter, we promoted Samantha Weeks to the chief transformation officer role to better align our human resources, learning and development, transformation, project management and mission assurance functions under a single department.\n\nHer team will identify and execute on various productivity improvements, and we are confident our initiatives will drive productivity, excellence and further margin expansion in excess of what we have already communicated earlier this year. I would be remiss if I did not comment on the current market environment adversely impacting financial technology companies, including Shift4. We strongly believe that there remains a disconnect between our growth and our valuation in the public markets. We have generated superior growth and are on track to deliver over 30% revenue growth and over 50% adjusted EBITDA growth this year and expect to generate over $100 million of adjusted free cash flow.\n\nDespite these results, an unparalleled performance during a completely unforeseen pandemic, we still trade well below what I believe to be our intrinsic value. Some will view these comments as self-serving, but I've challenged our company to thoroughly evaluate the cost of being a public company against this backdrop. We view our strategic initiatives, customer wins and operational tactics as highly valuable and even more so during times of economic uncertainty. Sharing them regularly is just one example of the unnecessary headwinds we face.\n\nSo with that, let me turn this call over to our president and chief strategy officer, Taylor Lauber. Taylor?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nThanks, Jared. And good morning, everyone. I will focus my prepared remarks on how we see our volumes trending for the balance of the year, an update on our acquisitions and then some additional color on our major strategic initiatives, which is primarily our gateway sunset initiative. Our previously provided volume guidance for this year assumed a modest recovery in international and business travel and $3 billion of contribution from the new verticals, such as nonprofit, Starlink, gaming and sports and entertainment venues.\n\nWe are benefiting from the ongoing resumption of travel evidenced by the sequential improvement in our lodging volume CAGR although the volume contribution from our new verticals had initially been slower to ramp than we would have predicted. This is both a benefit and a detriment. A detriment because we'd always like to see the volume sooner and a benefit because the work is complex and with complexity comes barriers to entry for our competition. Said more simply, the longer it takes, the more confident we are in our competitive positioning.\n\nThis is all to say that we are optimistic for our success in new verticals but still somewhat cautious on the macro environment. We did witness the typical seasonal uptick in volume throughout the quarter and into the month of July. Our hotel volumes continued to grow meaningfully month over month, and we continue to add new hotels at a decent clip. Our volume trends throughout July were consistent with our expectations, but we remain cautious on predicting volume trends for the balance of the year given the uncertainty around consumers' reaction to persistent inflation and rising interest rates.\n\nWe do believe that consumers will ultimately pull back on discretionary spending as food and fuel prices remain high but predicting how and when behaviors change remains something we believe everyone is struggling with. We are leaving our volume forecast unchanged for 2022. And despite the delay in new verticals, we find it very encouraging that the contribution from these verticals is starting to ramp up nicely. Turning to acquisitions.\n\nWe closed on the acquisition of The Giving Block on February 28 of this year and are working through the necessary European regulatory approvals for a fourth quarter close of Finaro. In regards to The Giving Block, the ongoing volatility in the crypto space has not altered our initial view that our right to win in the nonprofit space is improved by owning The Giving Block. And going to market with a differentiated offering that includes crypto acceptance provides us with a unique advantage. As you recall, we intentionally structured the transaction with a significant portion being tied to revenue targets in order to insulate from any shocks in the crypto markets.\n\nIn short, we believe that we are very well protected on our initial investment and the business continues to operate at breakeven. Nonprofits continue to get added to The Giving Block's platform, all of whom are paying SaaS revenues. The customer count is growing, and we remain cautiously optimistic heading into the end of the year as the majority of donations occurred during the fourth quarter and in December more specifically. In the meantime, we continue to execute on the $45 billion cross-sell opportunity and are improving the product every day, including adding the online widgets that Jared mentioned earlier.\n\nFor Finaro, we are pleased with our ability to deliver a cross-border solution for global e-commerce merchants and have successfully completed testing transactions between the U.S. and Europe. As Jared highlighted, we will begin processing U.S. e-commerce transactions for Skatepro, kiwi.com, as well as European transactions for Starlink later this year and are in discussions with many more.\n\nAs a reminder, we are not including any contribution from the acquisitions in our guidance but do anticipate a positive contribution in 2023. We are leaving our expected 2023 adjusted EBITDA and volume contribution for both Finaro and The Giving Block unchanged. As a reminder, for Finaro, we anticipate $15 billion of end-to-end payment volume and roughly $30 million of adjusted EBITDA contribution. And for The Giving Block, we anticipate roughly $5 million of adjusted EBITDA contribution.\n\nAs mentioned in May, we embarked on our gateway sunset strategy during Q2. You will recall that this strategy is comprised of numerous short- and long-term benefits to the company. It is designed to grow revenues, add end-to-end merchants and reduce operational inefficiencies. The pandemic slowed our business in many ways, not the least of which was delaying the implementation of these plans until just now.\n\nOur plan involves limiting our gateway-only offering, deprecating legacy connections and accelerating end-to-end conversions. Our process has been good, having identified roughly $4 billion on such connections and already converted approximately $700 million of that $4 billion. We have also increased pricing, which more appropriately assigns value for the critical services we're providing as a gateway. Another notable event during the quarter is the increased opportunities with regard to M&A.\n\nWe've been patient with our capital and suspect that these patients will be well rewarded as we look to execute interesting growth catalysts. As Nancy is in the process of onboarding to become our new CFO effective tomorrow, I will review the financial performance for the quarter. Q2 gross revenues were $507 million, up 44% from the same quarter last year. Gross revenues less network fees were $183 million, an increase of 34% over the last year.\n\nOur revenue growth breaks down as follows: first, a 43% year-over-year increase in net processing revenues, driven by the year-over-year growth in end-to-end boeing. Second, a 25% increase in our SaaS and other revenue stream driven by higher merchant counts in our high-growth core and expansion into new verticals. And finally, our gateway revenue stream was roughly flat year over year as a function of decreased transaction accounts from the gateway conversion I mentioned earlier, offset by a partial quarter of our recently launched gateway sunset strategy. Spreads for the quarter came in at 78 basis points, which is consistent with what we reported for the same period last year.\n\nSimilar to our discussion last quarter, Q2 of '21 spreads were depressed approximately 2 basis points because of higher debit mix from the issuance of last year's government stimulus. This is evidenced by our interchange rate, which has increased from 182 basis points in Q2 last year to a more typical 192 basis points this quarter. When adjusting for card mix, spreads in the second quarter of this year declined by approximately 2 basis points year over year. This is expected as we continue to expand into larger merchants and new verticals.\n\nFor the quarter, we reported adjusted EBITDA of $66 million, which is up 45% over the same quarter last year. The resulting adjusted EBITDA margin for the quarter was 36%, and which represents a 270 basis points of margin expansion over the same period last year. I want to note that we are continuing to invest methodically into our growth strategy while delivering this margin expansion. Adjusted free cash flow in the quarter was $16.4 million, which compares to a nearly neutral free cash flow position for the same period last year.\n\nIt's worth noting that Q2 also includes a semiannual interest payment of roughly $10.4 million, which can distort the quarterly comparisons. And in that regard, makes Q2 look even more favorable for this quarter. The current quarter result brings year-to-date cash flow to just over $30 million, which equates to a free cash flow conversion percentage of roughly 27%. And full reconciliation of the adjusted free cash flow is available in the appendix of our earnings materials.\n\nAnd then, with respect to capital transactions within the quarter, between April 1 and June 30, we repurchased approximately 3.6 million shares. Our buyback program has cumulatively purchased 4.3 million shares. And as Jared mentioned, we continue to believe the stock is meaningfully below the intrinsic value of the company. You can also see a reconciliation of our shares in the back of our earnings materials.\n\nYou will note that our guidance reflects both the cautious outlook on the consumer, but also a significant optimism in the performance of our business during the second half of the year. We believe that the gateway sunset strategy and early indicators for SkyTab and new verticals warrant a modest increase in our gross revenue less network fee outlook and are increasing our guidance range to $690 million to $710 million, up from $675 million to $705 million previously. We are also increasing our full year guidance on adjusted EBITDA and to $255 million to $265 million, up from $240 million to $250 million previously. Finally, we are reaffirming our previously discussed free cash flow conversion rate of 35% to 40%, but do expect full year free cash flow conversion to land toward the upper end of that range? Lastly, I'd like to welcome Nancy to our first earnings call.\n\nNancy Disman -- Chief Financial Officer\n\nThanks, Taylor. I've had the privilege of watching Shift4 from my seat as a board member and couldn't be more excited to join and expand on the great foundation, Brad has built in the finance organization. I also look forward to getting to spend time with our shareholders and analysts in the coming weeks.\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nAnd with that, Alex, we can turn it to questions.\n\nOperator\n\n[Operator instructions] Our first question for today comes from Ashwin Shirvaikar from Citi.Your line is now open. Sorry, Ashwin we're not receiving audio. Your line is now open.\n\nAshwin Shirvaikar -- Citi -- Analyst\n\nHey. Sorry about that. Can you hear me now?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYes, we got it.\n\nAshwin Shirvaikar -- Citi -- Analyst\n\nGreat. I wanted to ask with regards to gateway conversions. You seeing success maybe in any particular end markets? And obviously, you've had this arrow in your cooler for some time. Maybe could you review what's different now in terms of client receptivity and if there is economic weakness, would gateway conversions accelerate?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah, it's a great question. And I think -- thank you for asking because I think it's worth kind of reemphasizing exactly where we are in this trajectory, right? While we've had a ton of success adding end-to-end payment volume from restaurants and hotels through the pandemic, the reality is this is not at the top of restaurant, now it's all operators' minds during the pandemic. So I think our actions on the gateway have kind of increased the mind share that we have within these merchants minds through the quarter. And I think it's appropriate given where we are toward the end of this pandemic cycle that we've been realizing.\n\nIn terms of success. No, we highlighted a few examples just to show how diversified it is. We won some interesting healthcare opportunities. We had our board meeting at the Langham in Chicago, which is a beautiful hotel that we want as a result of these efforts.\n\nIt's really a function of which connections we've been prioritizing and how we're attacking those. The case study I cited in my remarks was identifying roughly $4 billion on connections, but quite frankly, have been around a very long time and need to be deprecated. And winning $700 million of annualized volume through just targeting those connections for discussions in the course of about a month and a half. So we feel good about our success rate.\n\nWe are approaching it methodically, given kind of exactly where we are in the economic cycle. And in terms of the receptivity, I don't think a downturn in kind of the broader economic cycle diminishes this. And in fact, I think it increases a merchant's desire to seek out kind of the most cost-effective solutions. I think every business operator we talk to right now is thinking longer and harder about expenses, and this is a more efficient solution economically.\n\nSo we don't think that while the consumer a slowdown in consumer spending could obviously decrease volume per merchant. We don't think it would slow down this initiative.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nYeah. And Ashwin, Jared here. Just to kind of hone in on the specifics of kind of what verticals in the gateway we're getting traction with. I mean, -- you can really see it in terms of lodging, right? And that makes sense because I think and I'm just going to give some approximate here.\n\nAt one point in time, we communicated that we believe across our gateways that we touch approximately 40% of the hotel lodging volume in this country. But from an end-to-end perspective, we've also communicated in the last quarter that we're approximately 10%. So there's a big gap between 10% and 40% that we think is it's easily accessible for us since we're already driving that commerce experience. And at Taylor's point, when they move over to our N10 platform, they're generally getting a lower cost of service.\n\nNow, hotel customers were not easy to pursue during the pandemic. Many of them furloughed their IT departments. They had a lot of other priorities they needed to think about other than migrating their kind of commerce providers. So long way of saying right now that we're having a lot of success winning lodging customers.\n\nWe have a long way to go, customers that are, again, very easily accessible, very easy for us to address. So even in the event there was -- there were to be some sort of a slowdown in travel and hospitality, the lift from -- the gross profit lift from that gateway customer moving to end-to-end is what's going to enable us to grow even if economic circumstances were to change this year, which is completely consistent with how we were able to grow during the pandemic when every one of our end markets was incredibly depressed and we still grew end-end payment volume by double digits. So I think lodging is definitely within our high-growth core an area where we're going to continue to have a ton of traction throughout this year and in two years ahead.\n\nAshwin Shirvaikar -- Citi -- Analyst\n\nGot it. And then, the other question was volume contribution from new verticals as we think of modeling the rest of the year? And maybe a point question on one specific client, Allegiant. It's one client, but it is a measurable client. Was that in your outlook previously, the specific timing, or has that timing also changed?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nSo we never gave any real specific customer targets in terms of volume. I mean, we might have given some approximations of what we thought they could represent at the investor day last year. We generally in our bridge said, in 2022, we're expecting a contribution of about $3 billion in end-to-end volume from our new verticals. So sure, I mean, if you were to look up what the Allegiant Airlines represent as a stand-alone customer relative to that $3 billion, you could say it's a big portion of it.\n\nAt the same time, there's a lot of other customers in there that are monsters. The idea was always that $3 billion target for 2022 in new verticals was to be viewed as conservative, no matter which direction you looked at it from the stadium side, from the Starlink side, from Allegiant side. So I guess probably the real message that we are trying to communicate this quarter is that integrations take a long time. It's largely dependent on third-party software companies that are powering commerce solution or the time that an enterprise customer is willing to commit to work through an integration.\n\nSo it did take a little bit longer, but they have essentially all come online with the exception of Allegiant in literally the last week of the second quarter, and it's now ramping pretty quickly as you can see from July. So whether Allegiant is delayed a week or not, whether Starlink is more than people would have expected or whether it's NCAA or NFL, like they're all going to be pretty meaningful contributors. You kind of just choose your own adventure, which one kind of carries the bulk of the weight in the second half of the year.\n\nAshwin Shirvaikar -- Citi -- Analyst\n\nRight, right. But basically, the $3 billion is still a decent number, and we can take that in traction into next year?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nFor sure. Allegiant is a big number, but I'd say, geez, I mean, you look at the NCAA stadium, the NFL stadiums we now have that we didn't have before Starlink, even we said BetMGM is ramping up significantly. We added several states just this week alone. So I guess what I'm saying is in terms of that $3 billion bridge in new verticals and certainly whatever they'll represent going into 2023, Allegiant is a nice part of it.\n\nSo is everything else, like they're all really beginning to fire.\n\nAshwin Shirvaikar -- Citi -- Analyst\n\nUnderstood. Got it. Thank you, guys.\n\nOperator\n\nThank you. Our next question comes from Tim Chiodo from Credit Suisse. Your line is now open.\n\nTim Chiodo -- Credit Suisse -- Analyst\n\nGreat. Thanks. Good morning, everyone. So I think Jared really hit on it in terms of ship force ability to have an idiosyncratic driver essentially despite the macro.\n\nGiven all the macro uncertainty, I think that investors are even more focused on the gateway conversion opportunity for Shift4 than ever. So to that point, I think, Ashwin's question really hit on it, but maybe as a follow-up, maybe you could just recap again the various approaches that you can take. So there's the cost that you have to maintain those connections. Of course, one is the sunset approach, but there's also sort of the quicker price increase.\n\nThere's the slower price increase and maybe some other initiatives that you're doing to help better monetize overall, even if it's not a full conversion. Maybe you could just provide some additional context on, maybe the mix of those approaches?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah, sure. Hopefully, you also pick up on Jared's comments around us being slightly hesitant to explain our detailed strategies in environments like this. But I'll give you the broad brushes and you captured the essence of it, right, which is that there are significant operational efficiencies to our organization for simply being less of a gateway and then there are significant revenue opportunities for us converting merchants end-to-end. And we balance those two approaches all the time.\n\nSo the first and I would say, softest of the approaches that we limited a series of activities that were related to our gateway-only customers. These are services that independent gateways would traditionally provide like moving from one processor to another. We limited those functions and saved several hundred cycles for our operations team every single month. That's an immediate win and, quite frankly, pretty low friction to all of our existing customers.\n\nWe also identified roughly $4 billion of connections that, quite frankly, should have been sunsetted longer. We had identified these connections in the end of 2019 when we acquired Merchant Link and it would have been an appropriate in our view to do so during the kind of peak of the pandemic. So that compelled a really nice wave of merchants to move over, and it's simply providing them notice these connections won't stick around for a period of time. I think we spoke about them at a lunch you hosted as well.\n\nSeparate from that, we have identified certain categories of merchants that are noneconomic and we just won't maintain that relationship in that context. In almost every case, that's resulted in a nice and meaningful revenue lift from that basket of customers, and we'll continue to do that as the initiative moves on.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nYeah. Jared here. I mean, there's so much to talk about with respect to the gateway sunset initiative and just the gateway conversion strategy in general, which really affords us a pretty unique right to win relative to others that kind of have what they kill out there. I'd say first, as part of gateway sunset, it's probably worthwhile to reinforce that one of our gateways that we acquired in late 2019.\n\nIt was a joint venture between two of the largest payment companies in the world and then intentionally underprice many of the customers on that platform in order to kind of capture the economics upstream of the gateway at one of those two financial institutions. I mean, almost to a ridiculous level. So just the fact that those agreements, some of them are dated 10, 15 years old, but they are absolutely enormous customers, are coming up for renewal. It's kind of a time to have a reset of what actually is the kind of fair value for the service that's being provided.\n\nAnd what it's doing is it's stimulating conversations on our end-to-end platform that had we not taken this approach, would never happen. I also want to go to the complete other end of the spectrum, which is not just kind of the stick based, but carrot based. The PCI council out there does a great service for us. Every four or five years, they pretty much declare that every EMV contactless device that's deployed in the country is no longer compliant.\n\nIn which case, every one of the customers is forced to consider a pretty large capital outlay. Now, we've always leaned in heavy in terms of the inventory we're willing to carry for EMV devices. We have our own PCI-validated key injection facility. So we maintain a chain of custody of those devices because we know at any given time, you could have a very large, several hundred location customers decide to move to our end-to-end platform, and we want to light them up rather quick.\n\nSo constantly, hotels large restaurants, even specialty retailers on our platform are coming up on decision points to replace those devices. We become the easy button. We can just encrypt them. We can deploy them.\n\nAs you know, we provide them at no cost as an inducement to move to our end-to-end platform. So it lines up saving that customer the initial capital outlay plus the ongoing cost of service is less by moving to our end-to-end platform. I just want to reinforce that the carrots that have helped us win and convert gateway customers for five years now are still driving a lot of the -- still driving a ton of the action that's going on in our gateway to end-to-end conversion process.\n\nTim Chiodo -- Credit Suisse -- Analyst\n\nThank you for that, Jared and Taylor, and congratulations to Nancy.\n\nOperator\n\nThank you. Our next question comes from Andrew Bauch of SMBC Nikko Americas. Andrew, your line is now open.\n\nAndrew Bauch -- SMBC Nikko Securities -- Analyst\n\nGood morning, guys, and thanks for taking my question. I wanted to touch upon some of the guidance here, it's suggesting gross profit margins for the full year being at 65% of net revenues. It implies a pretty steep ramp in the back half of the year. So can you just give us additional color on how we should think about that? And what are the key drivers there in the line items?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah, sure. This is Taylor. I'll cover that. I think the bulk of it comes from what we've witnessed in the early days of our gateway sunset initiatives.\n\nAs Jared mentioned in his scripted remarks, we're also incrementally positive and quite frankly, notably so on what we've got going with SkyTab POS as well. So those are the two most significant drivers of those two. We've got some contribution from new verticals as well. So that's going to ramp.\n\nAnd I would stick to those first to seeing a lot of starts.\n\nAndrew Bauch -- SMBC Nikko Securities -- Analyst\n\nIs that exit rate like a level that we should be modeling kind of in the out years?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nI don't -- I think it's too soon to predict that. I think that we feel highly confident in the end of the year. As you know, our success in new verticals can blend down our spread. And quite frankly, that can be augmented by SaaS success and SkyTab POS.\n\nSo I think it's just a little bit early to predict what kind of the outer year impact of this is. But coming into the back half of this year, we feel really good about margins.\n\nAndrew Bauch -- SMBC Nikko Securities -- Analyst\n\nGot it. And if I could just ask one more follow-up for Jared. Getting a lot of questions around some of your comments on your valuation being a public company. Can you just give us additional detail on how you're thinking about that?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nYeah. And in fact, let me just also throw a pile on Taylor's point to just what these new verticals represent. So it's hard for me not to draw like the history back to the basement days of the company. But for 18 years, we serve incredibly small customers.\n\nYour corner restaurants on main street, every one of those customers contribute a nice amount of volume, but and also a healthy service burden too. I mean, we have 2,000-plus employees now are very close to it in the company. You look at an organization like Adyen, which is a company we in many respects, aspire to be, their margins are very, very high. Free cash flow conversion is very, very high.\n\nThe volumes are very high. They're serving customers like Facebook and Microsoft and Amazon, where you're actually getting a considerable amount of volume, but your overhead to support that customer is next to nothing. In fact, like every bit of incremental volume can potentially fall to the bottom line. We'll look at the direction in our new verticals we're going.\n\nWe said Time Magazine in their digital subscription business that we announced. I mean, obviously, Starlink is enormous, stadiums are enormous. These represent sometimes hundreds or thousands small, midsized customers. And the support burden associated with them is just so much less.\n\nIt's actually surprising how many employees we needed for our first $50 billion of end-to-end volume and how many we expect to need for the next $50 billion of end-to-end -- $1 billion of end-to-end volume. So just wanted to make that point in terms of also as we start to look at the margin profile of the business and its free cash flow conversion going forward. My point on valuation and like -- you don't want to whine in an environment where all asset classes have been absolutely pummeled. But when you look at one point and say the Street is now valuing exit potentially inside of 10 times next year's EBITDA, actually effectively even less than that when you take into account now our guidance raise.\n\nAgain, this was a week or so ago, and we're assembling our materials on this. You're saying is the cost of being a public company worth it right now. And there's obviously the hard costs that we all know and understand when you make a commitment to be a public company. But then there's kind of a harder to quantify cost that comes with just essentially radical transparency.\n\nAs a private company, we certainly wouldn't want to clue our competitors into our gateway sunset strategy, right? I mean that you're basically revealing how you're going to convert up to potentially $200 billion of end-to-end volume. Every success we have on the gateway conversion strategy is pain -- it's pain to every one of our competitors, right? So at some point, when value drops to such an extent, you do ask the question is -- is this the cost we're willing to pay, especially with respect to the transparency obligations that come with being a public company. So I think that was what we were trying to communicate.\n\nAndrew Bauch -- SMBC Nikko Securities -- Analyst\n\nNo, I really appreciate the insight and congrats on the solid quarter.\n\nOperator\n\nThank you. Our next question comes from Scott Wurtzel of Wolfe Research. Your line is now open.\n\nScott Wurtzel -- Wolfe Research -- Analyst\n\nHey, guys. It's Scott on for Darrin here. First one I want to touch on was just on the net yields. I mean, even accounting for some of the normalized sort of debit behavior.\n\nI mean, we're still only down two basis points year over year, which I guess is a little bit sort of better than what we had expected historically. So I was just wondering if there was any sort of change to your outlook on the trajectory of yields even as you continue to penetrate larger merchants.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nI'm just going to beat the same drum which is that we continue to grow into larger and larger merchants. And so, this is something that the degradation of blended spread is something that our investors should continue to expect. A little bit delayed in part because I think we were slower in the new verticals than we'd hope to be in the first half of the year. It hasn't changed our optimism.\n\nIt hasn't changed our long-term view. In fact, our optimism has kind of been bolstered seeing kind of the last week in June and some contribution from those verticals. But that, if anything, is probably the reason that you've seen kind of spreads stay a little bit elevated. Is that new vertical contribution.\n\nScott Wurtzel -- Wolfe Research -- Analyst\n\nGot it. And then, just a follow-up. Just on the digital media vertical, it's interesting to see that win with Time Magazine. Just wondering if you can give a little color on sort of how you entered that vertical? And is it one that we should expect the company to continue to go after going forward?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nIf I was the artist behind the materials, I probably would have just lumped that into sexy tech, I think that -- let me expand on this a little bit right now. So we've announced some really, I think, exciting wins some at our industry day last year, we didn't deserve, but became a great opportunity for us to make investments in international expansion to build out our payment platform capabilities beyond what would just be expected for a restaurant or a hotel or specialty retailer beyond where we've been historically. We've started to get RFPs for surprising customers. And it's surprising in that I don't think a year or two years ago that I ever would have imagined we'd be able to compete for some of those brands.\n\nAlso not surprising in that without us in the mix, they really only had two companies or so to send it to. When you think of those large, powerful easily recognizable brands, you're sending it to Adyen and Stripe. And maybe you send it to JPM or one of the local banks here, but if you're a multinational player and you're looking for that single portal with cool capabilities, recurring billing, business intelligence, you're really in the Adyen and Stripe landscape and that landscape alone. So I think having some signature wins at Industry Day, again, about nine months or so ago, put us a little bit more on the map.\n\nAnd we've had to make investments in our capabilities in order to support those type of customers. So Time is one example of it. There's another one that we weren't allowed to -- there's actually two that we weren't allowed to announce that committed to us this quarter as well. So I'd expect more to land in that general sexy tech camp of hey, there's somebody else out there that can compete with some of the big boys.\n\nNow, we have a long way to go in terms of international expansion. If somebody needs a solution that's going to serve a couple of hemispheres here, we're not there yet. We've got Finaro. But as we mentioned in our capital allocation strategy, our No.\n\n1 priority is to continue to expand our reach in rails all across the world. And we think in doing so and get a lot more of those RFPs for those kind of sexy tech organizations, and we're pretty excited about it.\n\nScott Wurtzel -- Wolfe Research -- Analyst\n\nGot it. Thanks, guys.\n\nOperator\n\nThank you. Our next question comes from Andrew Jeffrey of Truist Securities. Your line is now open.\n\nAndrew Jeffrey -- Truist Securities -- Analyst\n\nHey, good morning. Appreciate you taking the question. Jared, I love to hear the ambitions and the aspirations to compete with what I think a lot of people would consider the best payments companies in the world. Along those lines, can you elaborate a little bit on how you think about Shift4 evolving into a true global omni solutions company? I think we're seeing this, I think, more pronounced trend, Shopify certainly, Amazon, moving off-line into physical point of sale, Adyen, I should say.\n\nCan you just sort of elaborate on how Shift4 looks from an omni perspective over the next several years? And whether you need different assets need to do M&A can develop all those capabilities internally?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nReally great question. So I mean, first, look, there is -- at a very high level, I talked to our team about this all the time. I mean, you can build $1 trillion organization very, very organically controlling your product road map right from the start, and I look at that as kind of an Apple model. Then you can take an Amazon model where you start with some great things, and you're not afraid of some M&A.\n\nI say all this knowing that Apple does do a fair amount of M&A these days. But kind of like a pure focus on product evolution versus Amazon bought awful lot of domains and a lot of companies over the years to become like a mega retailer. We look at our path as we start from an incredibly powerful card-present payment platform here in the U.S. That is very hard to do.\n\nNobody created a global commerce platform from a strength of card present period. It's just it's so much harder. I mean, you can take all of the card brands all across the world in a card-not-present arena without having to navigate the pain points of local debit networks through various EMV and PCI and other encryption certification challenges that exist like sometimes by country. You don't have to worry about any of those things in the card-present world -- in card-not-present.\n\nSo building out like an Adyen or Stripe platform globally from a card-not-present and APM focused world is easier. Now, we are way behind when it comes to international rails relative to those two companies. But we do have the strength of our card-present platform. We do have 450-plus integrations that have given us a unique right to win and grow in the U.S., that will be applicable anywhere in the world.\n\nWe just need to get those rails. And those rails are scarce. It's hard, and we're willing to do it inorganically. In fact, we're outright stating we're going to do it that way.\n\nFinaro is the first. It will not be the last. And I do believe with the organic investments we're making into our portal, our business intelligence product, our recurring billing capabilities, basically making sure the experience that our big, big name customer that we've mentioned before, has a comparable experience to Adyen in our portals, while behind the scenes, we build out our rails is the path to get us there. But yeah, we have a lot of work to do kind of in our -- in building -- either acquiring or building out those rails all across the world.\n\nBut we're on a -- we've got a great strategy and a great path to get there. So I know it was a long answer, but it's one that we spend an awful lot of time thinking about. We definitely think we're coming from a position of strength within the card-present world, but we've got work to do in terms of those international rails.\n\nAndrew Jeffrey -- Truist Securities -- Analyst\n\nHelpful. Thank you. Super.\n\nOperator\n\nThank you. Our next question comes from Eugene Simuni from MoffettNathanson. Eugene, your line is now open.\n\nEugene Simuni -- MoffettNathanson -- Analyst\n\nHi. Good morning, guys. Thanks for taking my question. I wanted to come back for a second to total end-to-end payment volume growth or 43% year over year.\n\nAnd I'm hearing, obviously, there is still a lot of puts and takes on macro impacts that are going on, some recovery from the pandemic, some new kind of macro uncertainty. And so, I'm wondering, can you give us, hopefully, quantitative, but if not qualitative dimension on how much is that rate that 43% that we see this quarter depressed by the macro uncertainties, headwinds versus what the normalized trend could be?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nGreat question, Eugene. I think we haven't gotten too much better at answering it. But what I would suggest is that we feel like our average merchant is quite healthy and let's ignore Q2 and let's talk about July, where we were up nearly double digits over June, which is the most significant ramp we've seen in recent years between the two months. So I think consumer spending is quite healthy.\n\nThis will be supported by card brand data all over the place. It will be supported by travel data. So we feel like the consumer is healthy. We just -- we also feel cautious as we have for kind of two quarters now about how that translates into the back half of the year when back-to-school happens, people -- more and more people go back into the office, etc.\n\nSo we're just increasingly cautious in that regard. Now, ballast being our caution is what we know we've got going on in new verticals, which is Jared mentioned, we're installing a ton of stadium as we did in July in preparation for August. So we feel really good about the contribution from that vertical, as well as all the other verticals that really began to ramp and we haven't wrapped up our Allegiant integration yet. So we're kind of balancing all of those, but I think our view on kind of our average merchant and the consumer is that they're quite healthy, up and through this morning.\n\nEugene Simuni -- MoffettNathanson -- Analyst\n\nGot it. Got it. OK. And then, a quick follow-up.\n\nSo you called out, I think, in your prepared remarks that M&A -- additional M&A is something you're looking at closely given where the valuations have come down. Can you give us a little bit more color on what would be the examples of assets or capabilities or markets that you'll be looking to enter with any potential new?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah. This probably touches Jared's point about like a reluctance to want to convey sensitive information. I'm very comfortable saying, though, that our priorities are quite consistent with what we laid out back in November. So valuations aside international expansion and capabilities that help deliver some of the things that Jared talked about to support these new verticals is a heavy emphasis of ours.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nThis is Jared again to really put stop the point. The No. 1 priority is expanding our reach and our rails to the world. people all over the world want fast internet.\n\nAnd we want to make sure we're able to power their payments, their subscription payments literally anywhere else in the world. And if we can do that, and we can bring all of the products and integrations that have made us really successful in the U.S. to every other part of the world where they should also find success. That is the number one kind of capital allocation priority for us right now is to deliver on one of the best customers any payments company could ask for that has ambitions to play at the same level as Adyen or Stripe.\n\nThe No. 2 priority is if along the way, we find anything that is consistent with our past playbook that will allow us to accelerate our kind of end-to-end growth within pretty much the verticals we're already in today. I wouldn't expect us to surprise you with any new verticals where we think we applied some creativity we might be able to win. I think it's about international expansion in support of an awesome customer and I think it's about finding ways that are consistent with our playbook to accelerate growth in our current verticals.\n\nEugene Simuni -- MoffettNathanson -- Analyst\n\nGot it. Thank you very much.\n\nOperator\n\nThank you. Our next question comes from Chris Brendler of D.A. Davidson.\u00a0 Chris, your line is now open.\n\nChris Brendler -- D.A. Davidson -- Analyst\n\nHi. Thanks. Good morning, and congrats on nice results. And just one kind of quick clarification question, if you don't mind.\n\nWhen you talk about new verticals and the ramp we're seeing in July, certainly pretty exciting stuff, is the July more the sexy tech? And just from your comments, it seems like sports entertainment may be the bigger opportunity of all these, at least in 2022. I just wanted to confirm that was the case. There's no other reason to get excited about football season, it sounds like. So I just wanted to see your thoughts were on how this ramps in the second half.\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah. So I don't want to get too specific on the contribution within each one. The one thing I would say about sports and entertainment is it's not as significant a contributor in July and that seasonality of the merchants that we cover. So there just aren't as many events at the locations that were installed that contrast that the fall is typically a much better time, and we're adding a lot of big name brands where there's a lot of volume.\n\nSo we feel good about it, but I don't want to sort of comment on the relative contribution. And if I let Jared comment on it, he won't stop talking, so he loves the sexy tech vertical.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nThat's right.\n\nChris Brendler -- D.A. Davidson -- Analyst\n\nJust on the sports side, like, it feels like the -- like the opportunity that you're capitalizing on there is happening faster than I would expect. Like these are big, large deals and you continue to sign up stadiums one after the other. Is there something different about that business that makes it easier to convert or to sign up? Is it the strength of your product? Or it seems like it's a pretty big undertaking for a sports venue to do this and I keep seeing an announced at announcement?\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nSo this is Jared here. I can take that one. This was a very specific product that we made, if you recall, I don't know, a little over a year ago, maybe 14, 15 months ago, based on our observations of what was going on in the sports and entertainment landscape. So if you think about restaurants, for example, if you have a nonintegrated terminal or a cash register, you're going to move to a point-of-sale system.\n\nOnce you move to a point-of-sale system, there has been no like radical changes in terms of how you ring up a cheeseburger. So you're probably going to use it for a really long time until maybe the cost of a Windows-based system, reach a point where you're ready to reinvest in a new system. Stadiums were different. Like for -- we definitely saw from our early experiences in sports and entertainment stadiums again, call it, two years ago, that there's going to be a massive shift toward mobile ordering, that everything is going to be run from the phone.\n\nYou're going to order your burger and your beer in your seat and you're not going to have to wait on a concession line stand. You wanted jersey or some other merchandise, you're going to order that from your seat or your mobile phone and you're going to walk in and you're going to pick up your jersey and you're going to walk out, you're not going to wait in the line. You want to make a bet first half bet, a second half gets a real-time betting, whatever you can do it all from your phone. That sports entertainment stadiums are going to introduce their loyalty and rewards programs through mobile applications.\n\nSo -- but recognizing that, we didn't bet on a refresh cycle in stadiums that eventually they're going to -- stadiums are going to move from a micro system or an agility system to a ship where it was. No, we've got to get in there with a mobile application that's going to do all of this and like really pivot away from kind of a prior generation of tech. And the bet is paying off. Every stadium wants this.\n\nIt's not an optional thing. I mean, once you go to a stadium once and you've got everything run off your phone, it's going to feel like you're going back in time to go to a stadium that doesn't. So every new kind of press release that comes out just becomes an additional form of motivation for the next stadium to want to get on board. Now, there is a kind of an interesting on-season, off-season thing that goes on.\n\nYou know one switching during -- when their league is in action. But as soon as league season ends, they kind of all want to sign up. And there really is no -- there's no one that's in close second at all in terms of the product capabilities we provide with menu next. So yeah.\n\nI mean, we're excited about the traction. I'm personally very pumped about the football season coming up. We've got some of the most exciting teams to watch on TV are now Shift4 customers, so even more reason to tune in on Saturday.\n\nChris Brendler -- D.A. Davidson -- Analyst\n\nGreat. And just one more quick one I get a little late here. Any like guide post your milestones on the Finaro regulatory approvals, like are we close because it seems like maybe a little bit more difficult just given the international nature and some of the other factors at play at Finaro and it sounds like once you get that regulatory approval, you're going to put the switch in Europe, does it happen that quickly?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah, sure. So there are three jurisdictions that we require approval from and we have it in two of them. I suspect it's two to three more months, maybe four. I don't like to bet on the productivity of European regulators, but we feel really good about the pace, and it's consistent with what we laid out at the announcement of the transaction.\n\nChris Brendler -- D.A. Davidson -- Analyst\n\nGreat. Thanks.\n\nOperator\n\nThank you. Our next question comes from John Davis of Raymond James. Your line is now open.\n\nJohn Davis -- Raymond James -- Analyst\n\nHey, guys. I'll make this one quick. Jared, earlier this year, when you guys laid out the guide, you kind of gave us a nice bar chart that showed the walk for your volume for the full year. Obviously, things have changed.\n\nIf we were to add a bar for kind of macro headwinds so far, kind of what you guys think, is it safe to say that could be a few billion dollars of volume that has macro staying the same, you would have gotten? I'm just trying to understand the magnitude of the macro headwinds that are kind of baked into the unchanged volume guidance.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nYeah. I think we really are -- we're really saying right now that we didn't raise our end-to-end volume guide for really two factors. One, it was a slow start to the year, we knew just from Omicron from the get-go. So we had work to do there.\n\nAnd two, new verticals did take longer. We did think some of those big names that really began firing in the last week of the quarter would have started a couple of months earlier, right? So that's really the heart of it. High-growth cores continue to do its thing. As Taylor mentioned, July is up nearly double digits month-over-month, so we have a lot of reasons to be optimistic.\n\nThis is really just being realistic. Like we -- when we sit around the table, we bring up the fact that the restaurant steaks are $90, $100 at some point or another, in less -- inflation starts to come down at a meaningful rate, you have to assume that some consumers are going to say, maybe tonight, not the night to go out for dinner. We have not seen that in the data, which I think is exactly what everybody has heard from all the other card brands from the payment companies, but we're just trying to be realistic about it. If the second half of the year is raging and all the new verticals are firing, well, this is why we get opportunities to check in with you every quarter to reset expectations.\n\nJohn Davis -- Raymond James -- Analyst\n\nOK. Appreciate that.\n\nOperator\n\nThank you. Our final question for today comes from Anita Zirngibl from SIG. Your line is now open.\n\nAnita Zirngibl -- Susquehanna International Group -- Analyst\n\nHi. Thanks for fitting me in. I just had a question on the total volumes. I'm not sure if you mentioned it already, but if you could just give some color on how sort of gateway plus end-to-end volumes are trending? Whether or not you've seen any kind of macro headwinds in that kind of overall volume?\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nYeah. No, we haven't seen any. And you should -- like the gateway is kind of has got a larger concentration of hotels than even our end-to-end book. So you would expect that that volume is like reasonably robust right now given what's going on in travel.\n\nAnita Zirngibl -- Susquehanna International Group -- Analyst\n\nSuper. Thank you.\n\nOperator\n\nWe have no further questions for today. I will hand back to Jared Isaacman for any further remarks.\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nReally appreciate everyone joining in. I know we talk about the Shift4 way of the leading parts to be more efficient. We'll look at doing that with some of the paragraphs of our script for the next earnings report. But I will say thanks -- we had a lot of talk about -- so thanks for kind of bearing with us.\n\nAnd we're really, really excited to be sitting here around the table with Nancy Disman, known her for a long time now, known her reputation even longer. Great addition to the executive team and excited to -- excited for you to hear from her in the weeks ahead. Thanks again.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nTom McCrohan -- Head of Investor Relations\n\nJared Isaacman -- Founder and Chief Executive Officer\n\nTaylor Lauber -- President and Chief Strategy Officer\n\nNancy Disman -- Chief Financial Officer\n\nAshwin Shirvaikar -- Citi -- Analyst\n\nTim Chiodo -- Credit Suisse -- Analyst\n\nAndrew Bauch -- SMBC Nikko Securities -- Analyst\n\nScott Wurtzel -- Wolfe Research -- Analyst\n\nAndrew Jeffrey -- Truist Securities -- Analyst\n\nEugene Simuni -- MoffettNathanson -- Analyst\n\nChris Brendler -- D.A. Davidson -- Analyst\n\nJohn Davis -- Raymond James -- Analyst\n\nAnita Zirngibl -- Susquehanna International Group -- Analyst\n\nMore FOUR analysis\n\nAll earnings call transcripts"}
{"id": "0082abfb-6607-4332-b553-6b3cce12b918", "companyName": "Wendys", "companyTicker": "WEN", "quarter": 4, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/03/01/wendys-wen-q4-2021-earnings-call-transcript/", "content": "Wendys\u00a0(WEN -0.73%)\nQ4\u00a02021 Earnings Call\nMar 01, 2022, 8:30 a.m. ET\n\nOperator\n\nGood morning. Welcome to The Wendy's Company earnings results conference call. [Operator instructions] Thank you. Greg Lemenchick, senior director, investor relations and corporate FP&A, you may begin your conference.\n\nGreg Lemenchick -- Director, Investor Relations and Corporate FP&A\n\nThank you, and good morning, everyone. Today's conference call webcast includes a PowerPoint presentation, which is available on our Investor Relations website, irwendys.com. Before we begin, please take note of the safe harbor statement that appears at the end of our earnings release. This disclosure reminds investors that certain information we may discuss today is forward-looking.\n\nVarious factors could affect our results and cause those results to differ materially from the projections set forth in our forward-looking statements. Also, some of today's comments will reference non-GAAP financial measures. Investors should refer to our reconciliations of non-GAAP financial measures to the most directly comparable GAAP measure at the end of this presentation or in our earnings release. On our conference call today are President and Chief Executive Officer Todd Penegor and our chief financial officer, Gunther Plosch.\n\nWe will give a business update, review our fourth quarter and full year 2021 results as well as our 2022 outlook. From there, we will open up the line for questions. With that, I will hand things over to Todd.\n\nTodd Penegor -- President and Chief Executive Officer\n\nThanks, Greg, and good morning, everyone. We had a breakthrough year in 2021 as evidenced by significant growth in our business, and we did so in partnership with our franchisees, restaurant crews, and suppliers. I'm incredibly proud of our consistent growth each and every year. We delivered on this again with an incredible 11th consecutive year of global same-restaurant sales growth and accelerated to double digits on a one- and two-year basis.\n\nThis was driven in part by growth in our breakfast business, which reached 8.5% of U.S. sales at the peak of our very successful Buck Biscuit promotion and global digital acceleration, which grew to approximately 10% of sales by year end. Our strong sales performance and commitment to the restaurant economic model led to company-operated restaurant margin expansion of almost 200 basis points in the face of historic inflationary pressures. We also made meaningful progress on expanding our footprint, opening more than 200 new restaurants across the globe in 2021 despite a very challenging supply chain environment.\n\nOur success is further evidenced by the continued return of cash to our shareholders in accordance with our capital allocation policy, where in 2021, we returned approximately $360 million through dividends and share repurchases. As we turn to 2022, we remain focused on our three long-term growth pillars: to build our breakfast daypart, accelerate digital and expand our global footprint. We believe that now more than ever, QSR is the place to be. And our mix of convenience, affordability, and speed position us to deliver against customers' evolving expectations.\n\nThe momentum we have built and our focus on execution are evident in the step-up in growth in our 2022 outlook that GP will talk through later. Our goal remains the same, which is to invest in driving efficient accelerated growth and we are delivering on that commitment. We have achieved our 11th consecutive year of global same-restaurant sales growth, which is a streak we plan to keep alive in 2022 and beyond. This growth extended across the globe with double-digit two-year same-restaurant sales in The U.S.\n\nand incredible double-digit one- and two-year same-restaurant sales internationally. In the U.S., these strong results led to dollar and traffic share growth, marking our sixth consecutive year of gaining or holding both dollar and traffic share in the QSR burger category. With the momentum that we have, we expect to continue delivering growth on top of growth across the globe in 2022 and beyond. Before I share more on our growth strategies for this year, I'll turn it over to GP to provide a few more details on our 2021 results.\n\nGP Plosch -- Chief Financial Officer\n\nThanks, Todd. We are very proud of our 2021 results, which far exceeded our initial outlook for the year and showcased the power of our business model. Global systemwide sales grew almost 12%, adjusted for the 53rd operating week in 2020. This was driven by our same-restaurant sales growth of 10% and approximately 2% net new restaurant growth.\n\nWe have also now reimaged 72% of all our restaurants ahead of our 70% goal for 2021. Company-operated restaurant margin expanded by almost 200 basis points to 16.7%, driven by our sales growth through a higher average check and an increase in customer counts. We also benefited from letting restaurant recognition pay in the second quarter. These increases were partially offset by an unprecedented increase in commodity and labor inflationary pressures.\n\nAfter adjusting for the 53rd week, adjusted EBITDA increased over 13% to $467 million. This was supported by our significant sales growth, an increase in net franchise fees, and company-operated restaurant margin expansion. These increases were partially offset by higher G&A expense and our incremental investment in breakfast advertising. Adjusted earnings per share increased almost 45% to $0.82.\n\nThis was driven by the increase in adjusted EBITDA and lower tax rate, lower interest as a result of our debt refinancing that we completed in 2021, lower D&A expense, and fewer shares outstanding as a result of our share repurchase program. Free cash flow increased significantly to $263 million. The increase resulted primarily from higher net income, the timing of accrued compensation payments, the impact from the cash payment related to the settlement of the financial institution case in 2020, and the timing of collection of royalty receivables. These increases were partially offset by an increase in cash paid for income taxes and cash paid for cloud computing arrangements, primarily related to the company's ERP implementation.\n\nNow let's turn to our fourth-quarter results. Global same-restaurant sales growth reaccelerated to double digits on a two-year basis, coming in ahead of our expectations for the quarter at approximately 12%. U.S. same-restaurant sales accelerated to 11.6% on a two-year basis, driven by growth across our core business, breakfast, and digital.\n\nOur game-changing fry innovation and compelling Buck Biscuit promotion resonated with our customers, helping us grow customer counts year-over-year, while also maintaining year-over-year check growth in the fourth quarter. Internationally, we delivered a third consecutive quarter of double-digit one- and two-year same-restaurant sales growth. This was driven by our largest markets, with two-year same-restaurant sales outperformance in Canada and in our Latin America and Caribbean region, which was driven by strong results in Puerto Rico and Mexico, one of our strategic growth markets. Our strong sales results also drove company restaurant margin to exceed our expectation for the quarter at 14.5%.\n\nYear over year, company restaurant margin decreased 300 basis points driven by record levels of commodity and labor rate inflation of almost 13% and 12%, respectively, and higher insurance costs. These decreases were partially offset by the benefits of sales leveraging, driven by the strength of our fourth quarter promotions. Our increase in G&A was primarily driven by higher incentive and stock compensation expense, as a result of our strong financial performance in 2021. Adjusted EBITDA decreased to $103 million, primarily due to the $8 million impact of rolling over the 53rd week in 2020.\n\nIn addition, there was a decrease in company-operated restaurant margin, higher G&A expense, and a decrease in franchise rental income. These decreases were partially offset by an increase in net franchise fees and higher franchise royalty revenue. The decrease in adjusted earnings per share was driven by lower adjusted EBITDA. This was partially offset by a decrease in interest and depreciation expense and fewer shares outstanding.\n\nWith that, I will pass things back over to Todd to talk about our plans to accelerate our growth even further.\n\nTodd Penegor -- President and Chief Executive Officer\n\nThanks, GP. Our playbook of investing to drive accelerated growth behind our three long-term pillars remains the same, and we believe we have the strategy in place to deliver in 2022. As we look forward, we still have many foundational growth opportunities on the horizon, like reopening all of our dining rooms, continued improvements in staffing, and fine-tuning our digital experience, all of which will set the base to drive our growth even further. Our plans are built on our foundational items of fast food done right, operational excellence, and good done right.\n\nEverything we do remains deeply rooted in the foundation of the restaurant economic model. We believe that our franchisees have never been healthier, and like us, continue to experience significant sales growth in 2021, putting us in a strong position to weather the near-term pressures facing in the industry. The combination of strong sales and margins fuels reinvestments into people, technology, reimaging and new development, which drives our confidence in growth for the future. Now let's walk through our strategies to continue to drive growth.\n\nWe continue to be extremely pleased with our breakfast business, which saw strong growth in the fourth quarter, peaking at more than 8.5% of sales in The U.S. and averaging approximately 8% during the quarter. This growth was primarily driven by successful promotions, which not only drove significant trial of our breakfast daypart, as evidenced by a meaningful increase in buyer penetration in the quarter, but also increased overall breakfast awareness to record levels. This culminated in another quarter of morning meal traffic share growth in the QSR burger category.\n\nAs we look back at the full year, we have made significant progress growing breakfast sales by approximately 25%. We achieved this through several successful trial-driving campaigns, continued increases in customer repeat, two additional months of the daypart and the support of our $25 million incremental investment in breakfast advertising. In 2022, we will add to our playbook to build the breakfast business as we support growth through menu innovation, such as our new craveable Hot Honey Chicken Biscuit alongside compelling trial driving offers to further ingrain the habit. We believe our breakfast business in The U.S.\n\nwill accelerate in 2022 by approximately 10% to 20%, taking average weekly U.S. breakfast sales to approximately $3,000 to $3,500 per restaurant by year end. We are shifting our targets to a dollars per week metric as this is how we track the success of the daypart. We plan to launch breakfast in Canada, our largest international market in the second quarter, which we'll expect will build on the outstanding momentum and share gains we've seen in the market over the last few years.\n\nThis will bring our percentage of the global system serving breakfast to approximately 95%. We will tailor our breakfast program to the Canadian market, but we will leverage our successful U.S. launch playbook, which will include a similar menu, minimal franchisee investments, and additional company advertising support. In fact, we already invested over $1 million in the fourth quarter to ensure our launch gets off to a strong start.\n\nWe are expecting similar results to what we have seen in The U.S. and anticipate that the Canadian breakfast launch will provide an approximately 3% to 4% lift to international same-restaurant sales in 2022. Finally, we plan to continue supporting our breakfast business with an approximately $16 million incremental investment in breakfast advertising in 2022. Approximately $5 million of the investment will support the Canadian launch, which represents a meaningful increase in the Canadian advertising budget.\n\nWe will continue to invest above and beyond in the U.S. with approximately $11 million to continue driving trial, repeat, and awareness to set us up for even more growth. We saw significant growth in our digital business across the globe in the fourth quarter, reaching approximately 10% of sales globally and exiting the year with a ton of momentum. Our international digital sales mix exceeded 15%, up versus the third quarter as Canada saw significant gains from the addition of Uber Eats as a delivery provider.\n\nOur U.S. digital business also accelerated during the fourth quarter, exiting with digital sales mix of more than 9% in December. This growth was driven by gains across both mobile ordering and delivery. We also saw meaningful increases to our loyalty program, growing total members by approximately 75% over the course of the year and growing monthly active users by approximately 25%.\n\nIn fact, our rewards program was recently recognized as one of America's best loyalty programs by Newsweek, rating factors like overall satisfaction and ease and enjoyment. For the full year, we achieved explosive digital sales growth of 75% versus the prior year, which contributed to our strong sales result through higher frequency of our active users and higher average checks across our digital platforms. We expect meaningful growth in our digital channels to continue across the globe in 2022 as we drive more people into our app with compelling offers through the strength of our growing loyalty program and innovation as part of our strategic partnership with Google to create best-in-class, frictionless experiences in Wendy's restaurants around the world. Our development momentum accelerated as we delivered 121 net new restaurants, marking our sixth consecutive year of net new restaurant growth and our highest net new growth in almost 20 years.\n\nThis growth includes successes across the globe with exciting milestones along the way, such as the opening of our first restaurants in the U.K., the opening of our 1,000th international location, and the opening of 30 Wendy's delivery kitchens with REEF across The U.S., Canada, and the U.K. We are still early in our journey with REEF, but we are pleased with the operation and performance of The Wendy's branded delivery kitchens. These kitchens are designed and operated solely as Wendy's locations and are operated the Wendy's way. We continue to expect REEF delivery kitchens to help us address underpenetrated urban markets and are excited about the partnership and all the growth that lies ahead.\n\nI'm extremely pleased with the results the team was able to deliver, growing net new restaurants by approximately 2%. While we achieved significant growth, we did experience supply chain impacts causing some delays in openings. However, we have now opened all the restaurants that were impacted by supply chain delays last year. As we look ahead, we expect a meaningful step-change in growth for 2022 as we continue to build on our strong foundation.\n\nWe are already off to a strong start, tracking right on plan through the end of February, and expect full-year net new growth of 5% to 6%. This is backed by a very strong pipeline and further supported by our significant development agreements across the globe. I also wanted to highlight our recently launched Own Your Opportunity campaign, which seeks to further unlock our growth potential by increasing the diversity of our franchise system. We have introduced new strategies and tools to drive this effort through our previously announced build-to-suit program and more competitive financial requirements.\n\nIn addition, we are also adding resources with a focus on recruiting, and we have developed innovative financial programs and partnerships with banks who share our vision for Wendy's owners who reflect the diversity of our customers. We believe this program will enhance our development pipeline and further solidifies our confidence in the plans we have in place to reach 8,500 to 9,000 global restaurants by the end of 2025. Everything we do at Wendy's is focused on bringing our vision of becoming the world's most thriving and beloved restaurant brand to life, and we believe we have the right plans in place to accelerate our growth even further. I will now pass it back to GP to share how our growth strategies ladder up to our 2022 financial outlook.\n\nGP Plosch -- Chief Financial Officer\n\nThanks, Todd. As we move into 2022, our playbook remains the same, we are poised to deliver another year of accelerating growth. Now let's take a deeper look into our key financial metrics, starting with global systemwide sales. We're expecting significant top-line growth in 2022 of almost $1 billion, with global systemwide sales growth of 6% to 8%.\n\nWe expect that same-restaurant sales will drive more than half of our systemwide sales growth in 2022, driven by growth in our core business, breakfast growth in The U.S., the launch of breakfast in Canada, and continued digital acceleration. We also expect a significant increase in net restaurant development to drive the remainder of our systemwide sales growth as we plan to grow our net new restaurant count by 5% to 6%. We are expecting that roughly half of our new unit growth will come from nontraditional delivery locations. Now on to adjusted EBITDA, which we expect to grow to approximately $490 million to $505 million.\n\nWe expect our strong top line to be our biggest driver of growth, benefiting both royalties and our core company operating restaurant EBITDA. Overall, we're expecting a company restaurant margin of 15% to 16.5% as the benefit from our anticipated sales growth, inclusive of over 5% of pricing, are being offset by high single-digit commodity and labor inflation pressure and a 50 basis points headwind from investments in the U.K. to support our continued launch in that market. We are also expecting a benefit to restaurant margin and EBITDA from our acquisition of restaurants in the Florida market, net of the sale of our New York market.\n\nFinally, we're expecting a tailwind as our incremental investment in breakfast advertising will step down to approximately $16 million from $25 million in 2021. These increases are being partially offset by lower net franchise fees as a result of an expected return to normalized franchise transaction activity. We also expect G&A to increase to approximately $250 million to $260 million. We are further investing in our development and digital teams to support the increased growth we expect to deliver in 2022 and beyond.\n\nWe are also expecting an increase in technology cost related to the company's ERP implementation, increased costs related to annual merit increases, increased travel as we are lapping low travel activities due to COVID, and additional cost to support the acquisition of franchise-operated restaurants. These increases are partially offset by a decrease in incentive compensation as our plan resets each year. The investments in growth we are making in G&A are being done in an effort to create a more efficient Wendy's moving forward. We anticipate that our G&A as a percentage of our global system sales will remain flat to 2021 and then start to come down as we move into the outyears.\n\nWe expect free cash flow from our base business to grow roughly in line with adjusted EBITDA driven by core earnings coming primarily from our strong adjusted EBITDA growth. These increases are more than offset by higher incentive compensation payment due to our outperformance in 2021, an increase in capex to approximately $90 million to $100 million, and an increase in cloud computing arrangement cost of approximately $15 million. We believe our investments in capex will set us up for even more growth in the future. This is being driven by an increase in company development, including the opening of additional restaurants in the U.K.\n\nand cost associated with the restaurants acquired in Florida and a roller was new double-sided grills in our company-operated restaurants, which we expect to more efficiently produce a higher-quality hamburger. The increase in cloud computing costs is primarily driven by investments being made to drive our digital business, being funded by our technology fee and the company's ERP implementation, which will drive efficiencies across our organization. Moving forward, we expect these costs to moderate significantly as the company's ERP implementation will be completed in 2023. These headwinds will be partially offset by lapping reorganization realignment payments related to a prior reorg of our field team.\n\nAll in, we expect 2022 free cash flow to land at approximately $230 million to $240 million. To close out our outlook discussion, I wanted to hit on EPS. The increase in adjusted EBITDA is the main driver in increase in our adjusted EPS outlook to $0.87 to $0.91. And we also expect to benefit from fewer shares outstanding as a result of our share repurchase programs.\n\nThese are partially offset by a higher tax rate as we lap Overstock.com and an increase in depreciation, primarily related to the acquisition of the Florida restaurants. The step-up in our 2022 outlook highlights the strong foundation and momentum we have built and the continued growth across our strategic pillars. To close, I would like to highlight our capital allocation policy, which remains unchanged. Our first priority remains investing in profitable growth, and we are continuing to showcase this through the investments we are making.\n\nIn the fourth quarter, we acquired 93 franchise-operated restaurants for $128 million as part of our ongoing system optimization initiatives. We remain committed to maintaining approximately 5% ownership and will buy and sell restaurants strategically from time to time as we seek to continually optimize The Wendy's system. We previously announced the declaration of our first quarter dividend of $0.125 per share, an increase of approximately 4%, which aligns with our capital allocation policy to sustain an attractive dividend payout ratio of more than 50%. We plan to utilize excess cash to repurchase shares and reduce debt.\n\nWe announced today a new $100 million share repurchase authorization expiring in February of 2023. Finally, we're in the process of evaluating a potential debt raise transaction within our securitized debt facility. If we decide to proceed with this transaction, we would expect to use the net proceeds in line with our capital allocation policy. We are fully committed to continue delivering our simple, yet powerful formula.\n\nWe are an accelerated, efficient growth company that is investing in our strategic pillars and driving strong systemwide sales growth on the backdrop of positive same-restaurant sales and expanding our global footprint, which is translating into significant free cash flows. With that, I will hand things back over to Greg.\n\nGreg Lemenchick -- Director, Investor Relations and Corporate FP&A\n\nThanks, GP. As we previously announced, we will be hosting a virtual Investor Day on Thursday, June 9, which we shifted due to the evaluation of our potential debt raise. During this event, we are planning to provide an update on our long-term strategic vision and reintroduce our long-term outlook, including updates on how we believe our U.S. and international businesses will deliver a new year of growth across our three strategic growth pillars.\n\nNow turning to our first quarter investor outreach events. To start things off, we will attend the JPMorgan Conference in Las Vegas on March 8, followed by the UBS Conference in Boston on March 9. We will follow this up with a virtual headquarter visit with Deutsche Bank on March 11 and a virtual NDR, focused on the New York market with Guggenheim on March 14. If you're interested in joining us at any of these events, please contact the respective sell-side analyst or equity sales contact at the host firm.\n\nLastly, we plan to report our first-quarter earnings and host a conference call that same day on May 11. As we transition into our Q&A section, I wanted to remind everyone on the call that due to the high number of covering analysts, we'll once again be limiting everyone to one question only. With that, we are ready to take your questions.\n\nOperator\n\nThank you. [Operator instructions] Your first question comes from Dennis Geiger from UBS.\n\nDennis Geiger -- UBS -- Analyst\n\nGreat. Thanks for the question. Wondering if you could talk a little bit more about the operating environment as it relates to staffing, the dining rooms, etc., how that impacted the quarter? And then, I think, Todd, you spoke to the opportunity for improvement through the year as it relates to staffing, as it relates to the dining rooms reopening. So just curious if you could provide kind of any more commentary around that opportunity and how you see that playing out?\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. Thanks for the question, Dennis. Yes, in the fourth quarter, we had about 85% at any point in time of our dining rooms open. That was about the same as we saw in the third quarter.\n\nSo we didn't see a market change quarter to quarter on number of dining rooms open. If you look at our progression of sales throughout the quarter, we really didn't see an impact from omicron during the course of Q4. Staffing was a little tighter throughout the quarter. Clearly, omicron played a role in impacting staffing at the restaurant level.\n\nBut we've been very encouraged recently as we're starting to see applicant flow pick back up. We're seeing staffing starting to improve. And as we focus on our growth initiatives and really creating great restaurant experiences through digital as we move into 2022, a big focus on working with our system will be to ensure that our dining rooms are open, so we can actually have folks come in and do mobile grab-and-go on a more regular basis, get our delivery drivers in and out. So we're encouraged about the trends that we're seeing right now.\n\nDennis Geiger -- UBS -- Analyst\n\nThanks, Todd. Appreciate it.\n\nOperator\n\nYour next question comes from Brian Bittner from Oppenheimer.\n\nBrian Bittner -- Oppenheimer and Company -- Analyst\n\nThanks. Good morning. My question is on the 2022 top-line outlook. The same-restaurant sales -- the implied same-restaurant sales outlook for more than half to the system sales growth, which suggests an above-average pace of comp growth in '22.\n\nSo is that primarily related to elevated pricing and additional breakfast gains or anything else you can flush out on the same-restaurant sales guidance to the global system sales guidance? And on the unit growth, I realized its contribution to system sales is going to be relatively low this year, particularly because it steps up throughout the year. But will the contribution from unit growth to system sales step up following '22 as this timing issue kind of dissipates?\n\nGP Plosch -- Chief Financial Officer\n\nTo your question on color on SRS, a couple of drivers. We clearly are driving core SRS growth in rest of day. As you've heard on the call, breakfast in The U.S. is going to accelerate further our overall growth with 10% to 20% growth there.\n\nSo that is lifting our SRS expectations with what you have seen potentially in the past. Also, our Canadian breakfast launch is not unimportant. It's going to lift our international SRS by about 3% to 4%. So that's a little bit of color on the SRS.\n\nAnd yes, we are pricing over 5% in 2022. That gets us to double-digit pricing on a two-year basis, and it's clearly providing a tailwind for us on the SRS number. As far as your question is concerned on unit growth, your observation is correct. About 50% of our unit growth is in nontraditional.\n\nNontraditional is, as such, had lower AUVs. And as you also might remember, a big portion and a big step-up of our nontraditional growth is driven through the launch of REEF kitchens. REEF kitchens, they have an AUV of around $0.5 million to $1 million. From a P&L point of view, however, it is accretive to our royalty rate since we are collecting about a 6% royalty rate income on that compared to our regular collection of about 4%.\n\nOn a go-forward basis, I would expect that our nontraditional development stays in the 40% to 50% range. So that the similar impact of unit growth is outperforming the impact on sales. I expect that to stay for the future.\n\nBrian Bittner -- Oppenheimer and Company -- Analyst\n\nThanks.\n\nOperator\n\nYour next question comes from Eric Gonzalez from KeyBanc.\n\nEric Gonzalez -- KeyBanc Capital Markets -- Analyst\n\nHey. Thanks for the question. Just a quick one on breakfast. I'm wondering to what extent the omicron variant may have set you back in terms of establishing those consumer habits? And do you expect that that $11 million that you're spending -- an incremental $11 million, is that relating to reestablishing those habits? Or anything you can -- any color you can give us on what you're seeing on the breakfast mix at the start of the year.\n\nTodd Penegor -- President and Chief Executive Officer\n\nEric, we've been very pleased with our breakfast performance. And as you think about our guidance for this year, $3,000 to $3,500 per restaurant. That's a nice step-up. As GP just said, 10% to 20% growth year on year.\n\nWhat we're really encouraged is traffic is now back in the fourth quarter to pre-pandemic levels on the breakfast daypart. Teams are starting to come back. They're different. They're skewed a little bit later in the morning.\n\nWe're seeing our peak half hours, the last two half hours of the morning. But we've been very encouraged over the last couple of quarters that we're starting to shift to see our mix shift back to that 7:00 to 9:00. So patterns are starting to come back. People are starting to return to work.\n\nSome of the changes in CDC guidance and the requirements around masks and comfort levels for folks getting back in the office will certainly help set us up for success into this year. So we're feeling really good about the momentum that we have in the business. The incremental spend that we'll have this year is a nice complement to continue to put our message out there and ensure that we can continue to drive trial, continue to drive awareness. And what we're really seeing is that continued nice repeat in the business.\n\nSo we're really encouraged about our breakfast daypart right now.\n\nEric Gonzalez -- KeyBanc Capital Markets -- Analyst\n\nThanks.\n\nOperator\n\nYour next question comes from David Balmer from Evercore ISI.\n\nDavid Palmer -- Evercore ISI -- Analyst\n\nThank you. A question on price and also on mix. I think you said that you're anticipating 5% price in 2022? And what was the price in 2021? And how is it now year over year in the first quarter? And also and relatedly, the mix impact, if you were to separate that impact to check from pricing, how is that in '21? And how do you generally view mix playing out in 2022?\n\nGP Plosch -- Chief Financial Officer\n\nDavid, so on pricing. So on the systems side in Quarter 4, the system price is slightly below food-away-from-home inflation. The company priced about 6% in the fourth quarter, and that was about in line with the food-away-from-home inflation we saw in the fourth quarter. If we step back on company on the year in 2021, we priced slightly below food-away-from-home inflation in 2021.\n\nSo we've preserved our pricing power, and we definitely expect to price north of 5% in 2022. We're going to watch value and value perception. You know about 30%, 35% of our consumers are making less than $45,000 a year. So we need to make sure that we are striking the right balance and maintaining value perception.\n\nMix and mix management was clearly a nice tailwind for us in 2021. We are managing that. We are innovating behind Made to Crave. We are marketing in that area relatively strongly.\n\nAnd as an outcome, we are getting positive mix messages. We are going to continue to do the same thing in 2022. We've just launched Hot Honey Chicken sandwiches for Made to Crave. Again, news to drive the platform and drive news on a go-forward basis.\n\nOperator\n\nYour next question comes from Gregory Francfort from Guggenheim.\n\nGregory Francfort -- Guggenheim Partners -- Analyst\n\nHey. Thanks. Maybe just one quick one. Does the guidance assuming the leveraging event happens, is that embedded in the guidance? And then my question is on the international side, that's a pretty big pickup in the performance.\n\nI think we've seen from some of your peers, strong improvement in Latin America. Was that the big driver? Anything just regionally on the international side of things?\n\nGP Plosch -- Chief Financial Officer\n\nSo on the potential debt raise, no, none of that is contemplated. So if you go to raise debt, the impact on interest expense and therefore, the impact on free cash flow and EPS is not yet contemplated in the guidance. And I think, Greg, Todd is going to talk a little bit about international.\n\nTodd Penegor -- President and Chief Executive Officer\n\nIn the international, our recovery has been widespread, Greg. We see a lot of momentum continuing in the Canadian market. Our average AUVs in Canada plus up over $200,000 during the course of the last year. We continue to have momentum in app market.\n\nThat is our largest international market. Puerto Rico, we continue to see significant gains. That business has been on absolute fire. And in fact, picked up about $500,000 to our AUVs year over year in the Puerto Rican market.\n\nThat's fueled a lot of growth. And we've seen a nice recovery also, as you mentioned, in Latin America, with Mexico performing quite nicely. So we are seeing widespread growth across the international business within the SRS numbers. And then very pleased with the launch of the U.K.\n\nbusiness as we get up and running, which is in SRS, but driving some nice sales growth.\n\nOperator\n\nYour next question comes from Jared Garber from Goldman Sachs.\n\nJared Garber -- Goldman Sachs -- Analyst\n\nHi. Thanks for the question today. I wanted to switch back to the franchise recruitment initiative that you announced yesterday. I know you've heard a little bit about that maybe on the third quarter, but we got some incremental color yesterday.\n\nCan you just talk about how you think that will help us to drive some of the longer-term unit growth for the brand?\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. No, we're really pleased to announce the Own Your Opportunity campaign that you saw come out yesterday. And it's been a culmination of a few things that we've been working on for a while. Building some new relationships with various banks to ensure that we can provide more access to capital to smaller franchisees entering the system.\n\nThe build-to-suit program that we brought in place really complements this program well, gives folks an opportunity to come in with a little less capital outlay as we support getting that restaurant ready up and running for them. And we took down some of the financial requirements, as you know, a few quarters ago, to really make sure that we are competitive with the rest of the industry. We think all of that will significantly drive opportunities to bring more diverse franchisees into our system, allow us to get into some of our underpenetrated markets, and continue to accelerate our growth not just this year, but as we build the pipeline into 2023 and beyond.\n\nJared Garber -- Goldman Sachs -- Analyst\n\nThat's helpful color. And then just one quick follow-up, sort of on the comments that you just made was one of the things that I was thinking about in terms of the underpenetrated markets. Can you help highlight what type of markets those might be? Are they more urban, more suburban or rural? Are there different pockets of the country that this program might help you penetrate as well? Any incremental color there would be helpful.\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. We've always talked, we're clearly underpenetrated in major urban markets. REEF is playing a big role on that with the delivery kitchens. It would be great to have even more hard assets into some of those markets and franchisees that represent the communities that those restaurants would be in.\n\nBut we also know we've got a lot of opportunity across the country in many of the smaller communities. And Wendy's is a great brand, great opportunity for folks to support the local community with access to Wendy's. And we're dramatically underpenetrated still relative to our peer group across the country. And we think this can stimulate some nice growth.\n\nJared Garber -- Goldman Sachs -- Analyst\n\nThanks for that.\n\nOperator\n\nYour next question comes from Jeffrey Bernstein from Barclays.\n\nJeffrey Bernstein -- Barclays -- Analyst\n\nGreat. Thank you. I just wanted to follow up on the pricing as it relates to franchisee profitability. I think you mentioned franchisees were doing quite well.\n\nIt seems like sales were strong, but as you acknowledge, inflation was outsized. So I'm just wondering whether the 5% or so pricing you took in '21 was enough to protect margins and profits? I don't know if you have any color on the range of pricing that we've taken, and maybe what you saw in terms of elasticity from a consumer demand perspective? Because it does seem like you mentioned, the lower-income consumer is vulnerable. Just wondering whether that is expected to be enough? Or if there's any risk in your mind to that elasticity based on that, I think you said high single-digit labor and commodity inflation? So just trying to get a sense of your confidence from that perspective.\n\nGP Plosch -- Chief Financial Officer\n\nJeff, as far as franchise profitability is concerned, we have not yet collected the 2021 financials. My hypothesis would be that we have done well. Your recollection is correct. Back in 2020, U.S.\n\nEBITDA in frame of the U.S. franchise system was increasing by about 18%. You have seen our margin performance. Our margin was up almost 20 basis points.\n\nWe had obviously the same inflation as they had to deal with. So I would have expected that they would have performed similarly in 2021. And therefore, I would expect they start in 2022 in a very healthy financial position. As far as impact on pricing, in terms of shock to the consumer, as I said in my previous answer, we stepped up our pricing in the company restaurants to about 6%.\n\nThat was about in line with the food-away-from-home inflation. And we reaccelerated the SRS in The U.S. to 11.6%. So from what we are seeing now is we have not seen really any impact on the price increases.\n\nFrom a market share point of view, we gained traffic and dollar share in the QSR burger category in the fourth quarter. And that now marks the sixth consecutive year of either holding or growing dollar and traffic share in the burger category.\n\nJeffrey Bernstein -- Barclays -- Analyst\n\nThank you.\n\nOperator\n\nYour next question comes from John Ivankoe from J.P. Morgan.\n\nJohn Ivankoe -- J.P. Morgan -- Analyst\n\nThank you. Morning. Thanks for taking the questions. I was hoping if you could go through some of the buckets of capex in that $90 million to $100 million guidance for fiscal '22? And maybe obviously, what I'm trying to get to is, is that the new level going forward? Does that have an opportunity to go down? Does it make sense that it would go up? And just the overall umbrella question is, do you think about capex as a percentage of EBITDA longer term for us to overall judge the capital efficiency or cash efficiency of the business?\n\nGP Plosch -- Chief Financial Officer\n\nJohn, I would have been disappointed if you wouldn't have asked the question on capital. So the capital is definitely up on prior year. We are stepping up, for the time being, our development capital. It's driven definitely a little bit by the acquisition, but more importantly, by building out our footprint in the U.K.\n\nWe're going to build about 10 restaurants in the U.K. in 2022. We also have something new, and I don't know whether you picked this up in our prepared remarks. We are also investing in a double-sided grill.\n\nSo the way to think about this it's a faster grill that produces a choosier burger. We are going to transform about 40% of our grill footprint in our company restaurants this year and finish this up in 2023. Our system is going to about 1/3 converted to the new grill. It should lead to increased sales since consumer satisfaction should be increasing.\n\nIt also will drive some labor efficiencies. So these investments that we are making here are really driving growth and therefore drive a financial return out of those capital investments. What we have also seen probably is that we have a headwind in our free cash flow on cloud computing arrangement. So that's technical -- just to be clear, that's not part of the capex line.\n\nThat actually sits on prepaid assets for -- but mainly for the ERP implementation and it gets amortized into the G&A line. So in terms of -- on a go-forward basis, we're going to stay elevated on the capital side in 2023, since we are going to continue to build out our U.K. footprint to about 35 restaurants. And as I mentioned, the double-sided grills, we do about 40% this year, the remainder in 2023.\n\nAnything beyond 2023, we'll give a little bit more color when we're all together for Investor Day beginning of June.\n\nJohn Ivankoe -- J.P. Morgan -- Analyst\n\nOK. Fair enough. Thank you.\n\nOperator\n\nYour next question comes from Chris Carril from RBC Capital Markets.\n\nChris Carril -- RBC Capital Markets -- Analyst\n\nThanks. Good morning. I think you mentioned breakfast awareness levels continue to grow in the 4Q. So can you provide any more detail on awareness? And I believe your expected support of breakfast of $16 million in '22 is only slightly higher than your previous guidance.\n\nDo you see potential for that support level to shift at all depending on breakfast performance either in The U.S. or Canada?\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. No, on the breakfast side of the business, we've been quite pleased with what we've been seeing along the way. Our repeat continues to be very strong. Awareness would rage record levels for us.\n\nWe're basically on par with Burger King, which has been in the business for a long, long time. And what we're really pleased is with a lot of the trial-driving promotions that we had out there, Buck Biscuit $1.99 croissant, we're bringing a lot of new users into the category and into the Wendy's breakfast arena. And we know that once we get great trial on our food, we do see really strong repeat. And that's why we're really confident the step-up that we're seeing as patterns start to come back in the morning routines to get to that $3,000 to $3,500 per restaurant.\n\nAnd what we're really encouraged is, is our legacy restaurants that had this before or launched two years ago are now running north of $4,500 per week. And those are the restaurants that had a little more reps on how you manage breakfast operationally, put a lot more time to ingrain that habit and the communities that they serve, which gets us really excited about where the growth can continue to go. As we roll into March Madness, we are the official breakfast of the NCAA, official breakfast to March Madness. We're also the official hamburger of the NCAA.\n\nSo you'll see a lot of messaging to continue to drive awareness as we move forward into the future.\n\nOperator\n\nYour next question comes from Lauren Silberman from Credit Suisse.\n\nLauren Silberman -- Credit Suisse -- Analyst\n\nThank you. I just have another follow-up with breakfast. Obviously, a very good job mix nearly 8% in the fourth quarter. With the goal to grow 10% to 20%, get to a 10% mix this year, I mean, is there anything you need to see in the macro environment? And then from a company-specific perspective, can you expand on how you're driving more trial?\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. If you do the math and you start to think about $3,000 to $4,500 per restaurant, and that's the way we look at it with our system as we look at that being significantly above breakeven profitability. If you work with rolls forward, we're probably slightly short of that 10%. But that 10% mix goal was just a step on the way of a journey to be a much higher percentage of our business over the long run.\n\nWe think there's a lot of legroom, a lot of opportunity to grow the breakfast in the future. As morning routines come back, as folks start to routine, move back into the office a little more, kids all getting back into school, all of those things play to continue to drive our business quite hard. And the disruptive promotions do get folks' attention. It allows us to talk about The Wendy's brand, to talk about the quality at a very great price point, and it does drive a lot of people in for trial.\n\nGP Plosch -- Chief Financial Officer\n\nAnd Lauren, the other thing I want to add is we have just talked about our legacy breakfast restaurants already. They have been really performing very, very well in 2021, well north of 10%. It has been longer added. And to translate that, it's about $4,500 per restaurant per week.\n\nContrast that to the $3,000 to $3,500 we are setting ourselves as rest of the system. So we have a lot of upside on the breakfast business here.\n\nLauren Silberman -- Credit Suisse -- Analyst\n\nGP, thanks so much.\n\nOperator\n\nYour next question comes from John Glass from Morgan Stanley.\n\nJohn Glass -- Morgan Stanley -- Analyst\n\nYeah. Good morning. Can you just help -- going back to The U.S. comps, can you just put the fourth quarter in context of third quarter when you saw some impact? And I noticed some staffing issues, you said it's a some macroeconomic impact.\n\nSo what were the big change factors that drove the sequential improvement on a one- and two-year basis on same-store sales in The U.S.? There was a line in the release that talked about increased customer counts. Was traffic impact therefore positive in the fourth quarter? Maybe just remind us where it's been? And if that -- if this quarter represented an inflection or maybe that had happened earlier on a customer count basis?\n\nTodd Penegor -- President and Chief Executive Officer\n\nOn customer count basis, we are up on a full-year basis. And we were up nicely into the fourth quarter. We did have only -- we still had about 15% of our dining rooms closed at any point in time in Q4 as we did in Q3, as I said earlier. But we had a really strong calendar across all the dayparts.\n\nIf you think about what we did on our hot and crispy fries, meaningful increases in fry attachment incidence rates in the fourth quarter, it's really helped us drive our customer count, while maintaining the check. And we saw really meaningful increases in our overall liking and repurchase intent on the fry business, and that's a gift that can keep giving. The Buck Biscuit promotion really drove a lot of new users into our breakfast category. So we were able to get a lot of trial, and we know we'll get a lot of repeat behind that.\n\nSo when you think about the strength of that calendar, along with some news around Made to Crave with big bacon cheddar, we felt good that we had a really good calendar to finish out the year. And we feel really good that we have an aligned calendar going into 2022 with the franchise community locked and loaded to continue the momentum.\n\nJohn Glass -- Morgan Stanley -- Analyst\n\nOK. Great. Thank you.\n\nOperator\n\nYour next question comes from Sara Senatore from Bank of America.\n\nSara Senatore -- Bank of America Merrill Lynch -- Analyst\n\nGreat. Thank you. I'm sorry to belabor this question, but I'm trying to piece all the commentary together. But the first question actually is just -- you're still evaluating a potential debt raise.\n\nCould you just talk about kind of what the considerations are? I think you said by the close of the first of this quarter, and we're two-thirds of the way through. So just kind of trying to understand how you think about that and how you would use it beyond obviously your standard capital allocation priorities. But just a clarification on the comp. You said customer counts are up.\n\nIs that different from what I would consider traffic or transaction counts? Because my understanding is in the fourth quarter, you had about six points of price and you still had some tailwind on mix from higher attach rates. So that's just more of a clarification question than anything else.\n\nGP Plosch -- Chief Financial Officer\n\nSo Sara on the debt raise. So just to set the scene here, at the end of the year, our leverage ratio was about 5.2 times. Our cash obviously went down in the fourth quarter compared to the third quarter, down to about $277 million as we finished our ASR and executed against debt one. And we paid for the acquisition, about $128 million.\n\nSo we are actually back to normal cash levels. In the context of anything going on, I think as long as interest rates are still staying relatively attractive, we are continuing to evaluate that. And we will -- if we go ahead and make the transaction, we would probably do this by the end of the first quarter. And proceeds will go toward whatever we always do in our capital allocation policy, either invest in growth of The Wendy's brand, dividends and/or share repurchases.\n\nThat I think answers your debt question. Todd, do you want to take on the --\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. Now, in the fourth quarter, just for complete clarity, Sara, our customer counts were up as well as our average check. So we had some pricing mix hung in there pretty darn well, but we're actually bringing more customers in through the door quarter-over-quarter and year over year.\n\nGP Plosch -- Chief Financial Officer\n\nAnd it's also worth pointing out it got 6% if you remember, it was for the company. The system has priced below food-away-from-home inflation. That's about a math on traffic growth plus pricing below food-away-from home inflation, adds up to the overall 6% comp growth.\n\nSara Senatore -- Bank of America Merrill Lynch -- Analyst\n\nThank you.\n\nOperator\n\nYour next question comes from Chris O'Cull from Stifel.\n\nChris OCull -- Stifel Financial Corp. -- Analyst\n\nThanks. Good morning, guys. GP, the domestic comps were well above estimates, but EBITDA was roughly in line, I think, with those estimates. And it looks like franchise rental income, franchise support costs were the primary reasons.\n\nHoping you could provide some more color on whether you were surprised by the performance of these lines and whether you think that will continue? And then also, if you could just tell us what you expect the 93 franchise stores the company acquired in the fourth to contribute to EBITDA this year. That would be helpful.\n\nGP Plosch -- Chief Financial Officer\n\nChris, you spotted it right, but what held us back a little bit on the EBITDA side, right? We came in on the top end of our sales guidance and came in kind of in the middle of our EBITDA guidance, and the answer is you spotted it on the rental expense line. As we acquired those restaurants, we had to take a one-time rental expense since we were less sore on some of those leases. And we had to adjust those leases and write them off, and that created a headwind for us from an EBITDA point of view. In terms of contribution of the 93 restaurants, we're expecting -- we are expecting in 2022, as part of our guidance, a tailwind of about $10 million to $15 million.\n\nAnd we expect -- basically, they also contributed a small accretion to our restaurant margin.\n\nTodd Penegor -- President and Chief Executive Officer\n\nThe acquisition of the Florida restaurants, and we also had the disposition of the New York restaurants earlier this year. So you had some ins and some outs during the course of company ownership during the year.\n\nChris OCull -- Stifel Financial Corp. -- Analyst\n\nThanks, guys.\n\nOperator\n\nYour next question comes from Jeff Farmer from Gordon Haskett.\n\nJeff Farmer -- Gordon Haskett -- Analyst\n\nGood morning. Thank you. You guys had mentioned that staffing is improving, but just looking for a little bit more color there. So are you guys actively pursuing staffing strategies with your franchisees? And then what percent of the system restaurants do you consider fully staffed at this point?\n\nTodd Penegor -- President and Chief Executive Officer\n\nWe've been given out fully staffed. But if you look at company restaurants, we're probably staffed a little bit better than the system. And we're not quite to 100% staffing, but we're trending in that direction. We'll have pockets that are better than 100%, pockets that are a little bit less than 100%.\n\nAcross the system, they're slightly less, but ebb and flow is picking up. And we're doing all the right things that we need to do. We're really making sure that we got the right compensation structure. We're ensuring that we've got the benefits in place.\n\nWe're really trying to lean in on a digital experience for the customers so we can actually curate a better crew experience. And The U.S. team has been very focused on creating great places to work, fund energizing, which really keeps folks engaged at the restaurant level. And we've been really pleased that, as we look at our Voice of Wendy's feedback, we've seen our employee engagement continue to increase, not just in company restaurants, but across the system over the last couple of years.\n\nJeff Farmer -- Gordon Haskett -- Analyst\n\nThank you.\n\nOperator\n\nYour next question comes from Brian Mullan from Deutsche Bank.\n\nBrian Mullan -- Deutsche Bank -- Analyst\n\nHey. Thank you. Just a question on the REEF partnership. I think you referenced there's 30 units open today in the prepared remarks.\n\nCan you just speak to how you're feeling about the performance versus your expectation? And then are you equally as encouraged across all three of the different markets that you have? And then finally, related on your current planning, do those REEF kitchen openings, do they accelerate in 2023 on the path through 2025 targets? Is that the current thing?\n\nTodd Penegor -- President and Chief Executive Officer\n\nI'll give you a little bit of color. So we opened 30 REEFs across The U.S., Canada, U.K. last year. Feeling very good about the performance in every market.\n\nOut of the gate, we're happy with it. REEF is happy with it. As you know, we've got a development commitment to do up in 700 restaurants. That was part of why we increased our 2025 targets.\n\nIn 2022, we just give you a little color, we're expecting to open about 150 to 200 REEF kitchens across the globe. About 65% of those will be in The U.S., about 10% of those would be in Canada, and about 25% in the U.K. And as we've always talked about, the range would be $500,000 to $1 million. And we're on track with our expectations.\n\nSo you'll still continue to see that nice ramp up in the future years, and we'll give a little more guidance and color on how that continues -- how that momentum continues at Investor Day in June.\n\nBrian Mullan -- Deutsche Bank -- Analyst\n\nThank you.\n\nOperator\n\nYour next question comes from Andrew Strelzik from BMO Capital Markets.\n\nAndrew Strelzik -- BMO Capital Markets -- Analyst\n\nThank you. Morning. Thanks for taking the question. I was just hoping that you could break out within the high single-digit kind of inflation guidance you gave, breakout between to cost and labor, and talk about the cadence throughout the year? And I apologize if I missed this, but how much visibility on the food cost side do you have?\n\nGP Plosch -- Chief Financial Officer\n\nSo we said like labor and commodities is high single digits. Think about 80% on each side. The main drivers on the commodity front is for our beef and chicken. I would also point out that commodity inflation and labor inflation are actually front-end loaded in the first half.\n\nWe also expect that sales on a one-year basis, it's a little bit lower in the first half compared to the second half. So as a result of it, we are expecting restaurant margin in the first half to be a little bit lower compared to the second half. So I hope that gives you a little bit of color on that.\n\nAndrew Strelzik -- BMO Capital Markets -- Analyst\n\nThank you.\n\nOperator\n\nYour next question comes from James Rutherford from Stephens.\n\nJames Rutherford -- Stephens Inc. -- Analyst\n\nGP, thinking about the fourth-quarter performance, are you able to share what the rest of day kind of two-year comps were all in? And maybe just stepping back a little bit, what are your main tactics and strategies for driving rest of day traffic through 2022?\n\nTodd Penegor -- President and Chief Executive Officer\n\nYes. If you look at our mix across all of our dayparts, breakfast, lunch, dinner and late night, our mix held pretty consistent in the fourth quarter with what we've seen in the third quarter. So we're seeing a nice balance, not just growing the breakfast daypart, but continuing to grow our rest of day business. And you see it.\n\nWe've got a lot of strong messaging on breakfast that halos back to rest of the day with the high-quality messaging. We continue to have a nice steady dose of news around Made to Crave. We've had activity around four for $4 and $5 Biggie Bags. So we do have a lot to offer in the spirit of high quality and affordable price relative to not just the QSR competitive set, but all the restaurant competitive set.\n\nAnd we'll continue to keep that pressure on. We've seen some innovation this year with the Hot Honey Chicken and the Hot Honey Chicken Biscuit Sandwich, breakfast, and dinner. And you'll continue to see a nice dose of innovation, both rest of day and breakfast as we go out throughout the year. So we feel really good that we've got a calendar in place that will resonate with the consumer throughout the year.\n\nJames Rutherford -- Stephens Inc. -- Analyst\n\nThanks very much.\n\nOperator\n\nYour next question comes from Nick Setyan from Wedbush Securities.\n\nNick Setyan -- Wedbush Securities -- Analyst\n\nJust a question on free cash flow. Just given the guidance in '22 and the capex commentary on '23, how should we think about that pre-COVID $350 million long-term target?\n\nGP Plosch -- Chief Financial Officer\n\nGood morning. Thank you. Nick. Yes, you should really feel good about free cash flow here, right? We achieved record cash flows in 2021 for about $100 million versus prior year.\n\nOur ability to convert profit into cash flow is very, very strong. As our EBITDA -- as our core free cash flow growth is in line with our EBITDA growth, yes, we have a little bit of a setback because we have the compensation payouts that we earned in 2021 that happens in 2022. So that's more of a one-time nature that is holding us back a little bit in our cash flow delivery. And yes, capital is clearly elevated this year.\n\nIt will stay elevated next year. It will fall off in 2023 as we are done with our ERP implementation. So the headwinds that we have on cloud computing arrangements is going to fall off and will further accelerate, combined with obviously expected continued strong growth on sales and profits.\n\nNick Setyan -- Wedbush Securities -- Analyst\n\nThank you.\n\nOperator\n\nYour last question comes from Joshua Long from Piper Sandler.\n\nJoshua Long -- Piper Sandler -- Analyst\n\nGreat. Thank you for taking the question. I was hoping you might be able to talk about how you're thinking about store-level operations as we eventually look to the dining rooms reopening and then also layering in some incremental menu innovation on the breakfast daypart. Just how you're thinking about that in the context of the operating environment with labor and then just going forward as well?\n\nTodd Penegor -- President and Chief Executive Officer\n\nWe've been focused over the last couple of years on a lot of things to really continue to drive op simplification. We fit some lower-performing items off the menu. We're really making sure that we've got a nice pace of innovation, where we're not overwhelming the restaurants. So we bring things in when the consumer and when the employee is ready for that.\n\nThe Made to Crave lineup plays really well into that innovation play because it's not just a 6-week LTO. It's an item that we train out for, and we have on the menu for quite some time. So we're really feeling good about how we have the pace of innovation against the labor market that we have. We are making some adjustments.\n\nWe've tested and tried curbside. Curbside will continue to exist, but that's another labor strain on the digital experience. And we're really trying to get folks to move to mobile grab-and-go and putting some racks in the restaurants to make it a little bit easier operationally for our teams in the restaurant. We've got operations tablets continuing to roll out that help us automate some of the menial tasks around scheduling and temperature checking and inventory management ordering in the back of the house.\n\nAnd we're really focused on getting more and more folks into mobile ordering, which really takes the pressure off of the order point and speeds up payment through the whole process. So all of those things are all little things that add up to make the restaurant more operationally efficient. And we'll continue to lean into what the flow of the restaurant looks like, not only for today but into the future as we drive more and more folks into digital.\n\nGreg Lemenchick -- Director, Investor Relations and Corporate FP&A\n\nThank you, Josh. That was the last question of the call. Thank you, Todd and GP, and thank you, everyone, for participating this morning. We look forward to speaking with you again on our first-quarter earnings call in May.\n\nHave a great day. You may now disconnect.\n\nOperator\n\n[Operator signoff]\n\nDuration: 65 minutes\n\nGreg Lemenchick -- Director, Investor Relations and Corporate FP&A\n\nTodd Penegor -- President and Chief Executive Officer\n\nGP Plosch -- Chief Financial Officer\n\nDennis Geiger -- UBS -- Analyst\n\nBrian Bittner -- Oppenheimer and Company -- Analyst\n\nEric Gonzalez -- KeyBanc Capital Markets -- Analyst\n\nDavid Palmer -- Evercore ISI -- Analyst\n\nGregory Francfort -- Guggenheim Partners -- Analyst\n\nJared Garber -- Goldman Sachs -- Analyst\n\nJeffrey Bernstein -- Barclays -- Analyst\n\nJohn Ivankoe -- J.P. Morgan -- Analyst\n\nChris Carril -- RBC Capital Markets -- Analyst\n\nLauren Silberman -- Credit Suisse -- Analyst\n\nJohn Glass -- Morgan Stanley -- Analyst\n\nSara Senatore -- Bank of America Merrill Lynch -- Analyst\n\nChris OCull -- Stifel Financial Corp. -- Analyst\n\nJeff Farmer -- Gordon Haskett -- Analyst\n\nBrian Mullan -- Deutsche Bank -- Analyst\n\nAndrew Strelzik -- BMO Capital Markets -- Analyst\n\nJames Rutherford -- Stephens Inc. -- Analyst\n\nNick Setyan -- Wedbush Securities -- Analyst\n\nJoshua Long -- Piper Sandler -- Analyst\n\nMore WEN analysis\n\nAll earnings call transcripts"}
{"id": "00852255-6682-40fa-ad1b-f48cee05f2fd", "companyName": "Hyster-Yale Materials Handling, inc", "companyTicker": "HY", "quarter": 3, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2021/11/03/hyster-yale-materials-handling-inc-hy-q3-2021-earn/", "content": "Hyster-Yale Materials Handling, inc\u00a0(HY -3.48%)\nQ3\u00a02021 Earnings Call\nNov 3, 2021, 11:00 a.m. ET\n\nOperator\n\nGood day, and thank you for standing by. Welcome to the Hyster-Yale Third Quarter 2021 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your first speaker today, Ms. Christina Kmetko, Investor Relations. Ma'am, please go ahead.\n\nChristina Kmetko -- Investment Relations\n\nThank you. Good morning, everyone, and thanks for joining us today. Welcome to our 2021 third quarter earnings call. I am Christina Kmetko, and I am responsible for Investor Relations at Hyster-Yale. Joining me on today's call are Al Rankin, Chairman and Chief Executive Officer; Rajiv Prasad, President; and Ken Schilling, our Senior Vice President and Chief Financial Officer.\n\nYesterday evening, we published our third quarter 2021 results and filed our 10-Q, both of which are available on our website. Today's call is being recorded and webcast. The webcast will be on our website later this afternoon and available for approximately 12 months. Our remarks to follow, including answers to your questions contain forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements made here today. These risks include, among others, matters that we have described in our earnings release issued last night and in our 10-Q and other filings 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.\n\nIn a moment, I'll discuss our current quarter results. But first, let me turn the call over to our Chairman and CEO, Al Rankin, for some opening remarks. Al?\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nThanks, Christina, and good morning, everyone. Our results for the 2021 third quarter are again very mixed, and most importantly, at a much lower operating profit and net loss level and we hit [Indecipherable] reporting.\n\nAs suggested last quarter, lift truck market demand during the third quarter continued to grow over 2020 levels. But as expected, it decreased from the second quarter of 2021 as markets moderated. As a result of the year-over-year market growth and share gain, Hyster-Yale bookings were strong and at high levels, which contributed to a new record lift truck backlog level, exceeding the historically high level achieved in the second quarter.\n\nGiven these factors, the lift truck business has robust production plans in place and is fully slotted -- and its plants are fully slotted for the remainder of the year and well into 2022. Last quarter, we indicated we expected significant losses for the third quarter at Hyster-Yale Group as a result of anticipated continuing supply chain constraints, significantly rising material and logistics costs, leading to margin contraction for trucks in the backlog, as well as our normal planned shutdowns.\n\nFurther, the global supply chain and logistics constraints we saw in the second quarter accelerated beyond what we were expecting, and their impact on Hyster-Yale became significantly worse, similar to the impact on a number of other companies. This exacerbated our component shortage issues and had a severe impact on our ability to ship units.\n\nAs a result, our third quarter shipments were only modestly higher than the second quarter and substantially lower than we expected, with the largest impact felt in our Americas division, where the ability to receive components needed to build certain trucks on schedule is poor.\n\nThese factors at Hyster-Yale Group, coupled with unfavorable inventory and equipment adjustments at Nuvera due to reduced near-term sales prospects, led to substantial operating profit losses and to net losses for the consolidated company for the third quarter.\n\nAs you would expect, given the impact of these supply chain and logistics problems, an expanded team is working diligently to obtain the components we need for production and to increase margins in our backlog and for new orders. Further, given the very high backlog, the opportunity for increased production and supply chain bottlenecks, our resolve is high.\n\nAfter Christina reviews the financial results for the quarter, Rajiv will provide more detail on these supply chain challenges as well as provide an update on our business operations and strategic projects. Ken will then discuss our financial outlook in this very difficult and dynamic environment. Christina?\n\nChristina Kmetko -- Investment Relations\n\nThanks, Al. I'll start with high-level comments about the quarter and then discuss the individual segments. As Al mentioned, due to market level changes and share gain, we had a 63% increase in lift truck bookings over the third quarter of 2020, but our bookings of 37,100 units decreased 20.9% from the extraordinary record level booked in the second quarter. We ended the third quarter with a historically high backlog of 98,800 units.\n\nOur third quarter unit shipments increased 12.6%, primarily driven by our EMEA and Americas segments, and our revenues increased 14.7% from the prior increases in the lift truck business were the primary drivers for the increase in our 2021 third quarter consolidated revenues to $748.2 million, up from six in the prior year.\n\nDespite the higher revenues, we reported an operating loss of $54.3 million compared with operating profit of $7.3 million in the prior year. This was the result of [Indecipherable] operating expenses of $13.7 million, primarily due to the elimination of many of the cost containment actions taken in 2020.\n\nIn addition, as a result of a reduced [Indecipherable] net realizable value in the near-term and recorded a $10 million fixed asset impairment charge to reduce the carrying value of its fixed assets to market value. As a result of these factors and a $38.4 million charge to establish a valuation allowance on certain U.S. deferred tax assets, which Ken will discuss in more detail, we reported a consolidated net loss of $77.2 million compared with net income of $5.1 million in the prior year quarter.\n\nTurning to the segment results. Our lift truck business reported an operating loss of $21.3 million, down from operating profit of $16.2 million in the prior year quarter, primarily due to a significant decrease in gross profit and higher operating expenses in the Americas and EMEA segments, both resulting from the specific factors I noted in the discussion of our consolidated results.\n\nBy far, our Americas division felt the greatest impact of production delays and higher costs with EMEA experiencing the same difficulties, but to a lesser extent. However, in JAPIC, the lower gross profit was mostly offset by lower operating expenses. Bolzoni's revenues for the 2021 third quarter increased 42.2% over the prior year. Despite these higher revenues, higher material and freight costs and component shortages resulted in Bolzoni reporting breakeven operating results, which were comparable to the prior year quarter.\n\nFinally, at Nuvera, revenue decreased to $200,000 in the third quarter from $700,000 in the prior year. As a result of the $24.8 million of unfavorable inventory and fixed asset charges, Nuvera's operating loss was $32.5 million, up from $8.7 million in 2020.\n\nThat completes the update of the results for the quarter. Now, let me turn to Rajiv, who will provide an overview on our operations and our strategic projects.\n\nRajiv K. Prasad -- President\n\nThanks, Christina. Our sales team continued to improve the market share in this strong market environment. The global lift truck market increased approximately 23% over the prior third quarter. But compared to the second quarter, the market decreased more than 14% due to downturns in all markets, except Latin America. The market improvements over the year -- prior year quarter, combined with our share gain programs as well as long lead times and the pull forward of orders before price increases went into effect translated into an increase in the company's 2021 third quarter bookings that exceeded market growth.\n\nWe expect the global lift truck market to decline in the fourth quarter of 2021 compared with the prior year fourth quarter and that markets in 2022 will recede from the historical highs of 2021. However, both periods are expected to remain significantly higher than pre-pandemic levels.\n\nAs a result of this market outlook, our lift truck business is anticipating a substantial decrease in bookings in the 2021 fourth quarter compared with the third quarter of 2021 and in the succeeding 2022 quarters compared with the respective 2021 quarters. Many industries, including our own, are experiencing a significant increase in demand as markets recover, and this is causing significant stress on the global supply chain, which has significantly intensified over the past quarter.\n\nOur supply chain group has continued to work diligently to address the challenges related to component shortages caused by supplier constraints and logistic challenges. These challenges are arising due to shipping space availability in China, congestion at U.S. ports and the shortage of truck available to move the goods once they're received at a U.S. port as a result of the general lack of truck availability and labor shortages.\n\nAll of these factors have limited our ability to receive parts at their originally scheduled time. We have put significant effort into securing components through other channels, including different shipping methods and other vendors. However, the limited availability of alternative shipping methods and build-to-order highly configurable -- configured nature of our components mean that alternative vendors that can provide the necessary components are very limited. And therefore, counteracting these constraints successfully has proven to be very difficult.\n\nAs a result, despite the high backlog, unit shipments were only modestly higher than the 2021 second quarter. In fact, these factors led to a large increase in backlog over the 2021 second quarter and to a new historically high backlog level. This has extended delivery lead times substantially.\n\nOur single most significant issue right now is managing margins in our record backlog for new orders. At our lift truck business, we have implemented price increases several times over the course of 2021 to address the effect of material cost inflation. But many of the orders in our backlog slated for production in the remainder of 2021 and the first half of 2022 do not reflect the full effect of all these price increases.\n\nAs a result, we expect to continue to experience low margins in the fourth quarter of 2021 and our best in the first half of 2022. Due to the lag between unit price increase went into effect and when they are realized as the units are shipped, nevertheless, the lift truck sales team is working to try to improve these backlog margins.\n\nThe team is also working diligently to ensure new orders are booked at target gross margins based on the future dates, they will be shipped, mainly given the current backlog in the fourth quarter of 2022.\n\nNow, let me spend a few minutes discussing our strategic initiatives, the lift truck business has three core strategies that are expected to have a transformational impact on our competitiveness, market position, and economic performance. The first is to provide lower cost of ownership while enhancing customer productivity.\n\nThe primary focus of this strategic initiative is our new modular and scalable product -- project, which are expected to lay the groundwork for enhanced market position by providing lower cost of ownership and enhanced productivity for our customers, including low-intensity applications.\n\nAdditional to this, our key projects geared toward electrification of trucks for application now dominated by internal combustion engine trucks, automation, product options, and telemetry, along with operator AFES systems.\n\nOur second core strategy is to be the leader in the delivery of industry and customer-focused solution. The primary focus of this strategic initiative is transforming our sales approach by using an industry-focused approach to meet our customers' needs.\n\nFinally, the third core strategy is to be the leader in independent distribution. The focus of this strategic initiative is on our dealer and major account coverage, providing dealer excellence and ensuring outstanding dealer ownership globally. Bolzoni continues to focus on implementing its one company three brand organizational approach to help streamline corporate operations and strengthen its North America and JP commercial operations.\n\nIt is also working to increase its Americas business by strengthening its ability to serve key attachment industries and customers in North America markets but through the introduction of a broader range of locally produced attachments with shorter lead times, while continuing to sell cylinders and various other components produced in Sulligent, Alabama plant.\n\nBolzoni is also increasing its sales, marketing, and product support capabilities, both in North America and Europe based on industry-specific approach with an immediate focus on paper, beverage, appliance, 3PL, and automotive industries. Nuvera continues to focus on serving niche, heavy-duty vehicle applications with expected strong near-term fuel cell adoption potential, using its 45 and 60 kilowatt engines, which were both released for sale late in 2020.\n\nAs a result of these releases, Nuvera accelerated its 45 kilowatt engine commercialization operation for the global market. In the fourth quarter of 2021 and in 2022, Nuvera will continue to focus on ramping up demonstration quote and booking for these products. In addition, Nuvera has initiated development of a new 125-kilowatt engine and continues to focus on applications in the forklift truck market.\n\nOverall, we continue to believe we have the right strategies in place for long-term growth once we can achieve resolution of component shortages and relative stabilization of material and freight costs. I'll now turn the call over to Ken for an update on future quarters and liquidity. Ken?\n\nKenneth C. Schilling -- Senior Vice President and Chief Financial Officer\n\nThanks, Rajiv. As you've heard from both Al and Rajiv, during the first nine months of 2021, we have experienced shipment levels, which are far lower than our objectives due to supply chain logistic constraints. The results stemming from these challenges contributed to our need to book a valuation allowance against our U.S. deferred tax asset, which Christie mentioned in her remarks.\n\nThe valuation allowance was established based upon a review of our current -- of our recent operations, including cumulative U.S. pre-tax losses, lack of available tax planning strategies, and declining forecasts due to supply and logistics constraints.\n\nDue to these factors, the evidence no longer supported realization for our U.S. deferred tax assets and the accounting rules required the need to record a valuation allowance in the third quarter. We expect to continue to experience supply chain logistic constraints in the 2021 fourth quarter into at least the first half of 2022.\n\nNonetheless, we are expecting 2021 fourth quarter shipments to increase over the prior year fourth quarter and third quarter of 2021. Significant material cost inflation and higher freight costs, which have continued to worsen in the 2021 third quarter and the current nonrenewal of the U.S. tariff exclusions are expected to continue to affect the cost of components and freight negatively over the remainder of the year compared with the prior year.\n\nWe continue to work aggressively to manage the supply chain, logistics costs, component availability and tariff exclusions and will adjust our prices for all new orders accordingly. Nonetheless, as a result of these factors and the increase in costs associated with the reinstatement of pre-pandemic salaries and benefits, we expect significant operating and net losses in the lift truck business in the 2021 fourth quarter and in the first half of 2022.\n\nAs a result of core strategies discussed by Rajiv and the increased shipment volume potential of the higher-priced lift trucks in our current backlog as well as the Q4 2021 and 2022 anticipated bookings, we expect the life truck business to return to an operating profit in the second half of 2022. However, for this to occur, we are assuming the stabilization or reduction of product and transportation costs and the continued expectation of improved component and logistics availability.\n\nIn addition, over this period in the longer term, we are also assuming the continued introduction of the currently released and additional modular and scalable product families and the continued implementation of cost-saving initiatives.\n\nAt Bolzoni, we expect operating profit and net income to increase in the fourth quarter compared with both the prior year period and the first nine months of 2021. Over the course of 2022, we expect Bolzoni's component shortages to moderate in pricing to permit improved returns as the year progresses despite higher costs.\n\nOn a consolidated basis, given the extensive component shortages, significant material and freight cost inflation as well as continued losses at Nuvera, we expect to have a significant operating net loss in the fourth quarter of 2021 and the first half of 2022. Consolidated results are expected to return to an operating profit in the second half of 2022, assuming reasonable resolution of component shortages and relative stabilization of material and freight cost.\n\nWe also expect to have moderated reduced losses at Nuvera as a result of enhanced fuel cell shipments. While we expect to make additional investments in the business during the remainder of the year and in 2022, maintaining liquidity will continue to be a priority. We have adequate borrowing facilities in place to help us weather these near-term challenges.\n\nAs at September 30, we had ash on hand of $61.4 million and debt of $428 million compared with cash on hand of $87.5 million and debt of $345.7 million at June 30. We were fortunate to be able to refinance our revolving credit facility and expand our term loan facility in the second quarter of 2021 to finance our growth and working capital needs during this challenging period.\n\nAs of September 30, we had unused borrowing capacity of approximately $245.9 million under our revolving credit facilities compared with $313.9 million at June 30. I'll now turn the call back over to Al.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nAs we finish 2021, we will be focused on managing effectively in a challenging and dynamic environment. We continue to execute our near-term, our mid-term, and long-term strategies and remain focused on the safety of our employees. Our strategy for the longer-term is clear and transformative.\n\nOur key projects as well as the explicit objectives for the lift truck, Bolzoni and Nuvera businesses support this long-term strategy. But near-term prospects are uncertain as a result of a number of abnormal largely external influences, as we've discussed, specifically suppliers' manufacturing levels around the world and logistics issues, which collectively create supply and cost challenges. As well as the timing of adoption rates for key fuel cell market segments.\n\nEnd markets are strong. We have record lift truck backlog, a strong current booking environment, and we are working diligently to manage the supply chain headwinds. We are continuing to invest in innovative products to meet increased customer demand. As a result, we believe future increased shipment opportunities are very significant.\n\nHowever, it is difficult for us to forecast when these increases will occur, given the supply and logistics difficulties. Nevertheless, when these challenges are behind us, we believe we will deliver solid sales and earnings performance, and that our long-term strategies and prospects will have a very significant impact in the future. We will now turn to any questions you may have.\n\nOperator\n\n[Operator Instructions] Your first question comes from the line of Chip Moore from EF Hutton. Your line is open.\n\nChip Moore -- EF Hutton -- Analyst\n\nGood morning. Thanks for taking my question. I was wondering if you could maybe drill into pricing actions a bit more in relation to the current backlog, particularly in relation to margins, right? We've talked about layers in the past. This quarter was, I think, the lowest margin level in at least the last decade.\n\nAre we thinking about modest sequential improvement over the next couple of quarters, assuming things don't get worse on the supply chain front? And then also maybe you could speak to mix a little bit. How much of an impact was that this quarter? And how do things look in backlog?\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nRajiv, you want to take that?\n\nRajiv K. Prasad -- President\n\nSure, Chip. I think the first thing to say with our -- as we've talked about our supply chain challenges, we're generally building trucks that we've booked in the fourth quarter of 2020 and first quarter of 2021. I think mix is not a huge factor. The primary driving force in our margin compression is commodity price increases, which has been not linear, but one would call them exponential, at least early on in the process. They sustained for a lot longer than we were expecting or I think anybody else was expecting.\n\nAnd then the secondary hit was the challenge with logistics. I don't know if you've been tracking that, but we have global supply chain and freight costs from the East. To give you a sense for it, a typical 40-foot container used to cost us $2,000 to $3,000 to bring in. And last quarter, we had spot prices of up to $30,000 for the same container. So those were certainly unpredictable and had a huge impact on our margin compression.\n\nNow, we do expect we'll continue to build backlogs that were booked in the first and second quarter through the fourth quarter. And then in the first half of the year, we'll build things that were booked in the -- up to the third and into the fourth quarter of this year. So margin, as Ken said, the margins will improve as we build trucks that have been booked more recently with more of the pricing in it.\n\nThe last thing I would say is the trucks we're booking right now have the full price to cover all the inflations we've seen. The unfortunate thing is we don't see ourselves building these trucks well into the third quarter of 2022, just because of the backlog.\n\nI don't know if that can answer.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nI'd add just a couple of things to that. The price increase has started most aggressively at the beginning of this year, I think, roughly speaking. And then as costs for the future were accelerating, we put more increases in place at various different times between the January, February period and in fact, quite recently.\n\nSo we've been trying to respond to future -- to forecast of future prices out in the time that trucks were meant to be shipped. Unfortunately, that process is long and it's been uncertain. And so as the cost increases have accelerated, it's been very difficult to catch up.\n\nI would say that as far as future cost increases are concerned that relate to bookings we're making now that we're being very careful about assuming any price moderation. And in fact, we're assuming certain kinds of cost increases. So that we're trying to be very conservative about our cost structure for trucks that are now being booked that will be shipped more or less, nine months to a year from now. So that's another dynamic that's going on in this whole process.\n\nBut the cost -- the future cost just accelerated at a faster rate. And as shipments, as has been outlined, were later, and that caused us to have this buildup. But the level of the price increase is accelerated. And therefore, we should be catching up on it as we go forward over the quarters of 2022.\n\nChip Moore -- EF Hutton -- Analyst\n\nThat's helpful. Thanks. And my second question was around capex. I think we were talking about $50 million before in the back half of the year. And I think that's a little bit lower now. Obviously, if we take the focus on liquidity, it's in this unprecedented environment. But just curious if that's delaying any of the strategic initiatives? Or if everything is on track there?\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nLet me just say that we are scrubbing our capex, as you would expect in this environment. But we're working very hard not to do anything that would delay critical strategic programs, especially those that would relate to share gain and the implementation of those kinds of long term programs, product and sales and marketing programs.\n\nSo I feel that on the capex side, it is a very, very disciplined process for both this year and next year. But I think the perhaps even more important thing to understand is that we have an enormous inventory bubble that is related to past due trucks that have been hung up because of the supply chain shortages that have had an impact on us.\n\nSo what we've done -- what we're focused on now is making sure that we produce those past due trucks, bring down that inventory and working capital bubble very dramatically. And then are only purchasing new inventory that clearly can be built given the supply chain constraints that we're operating under. So I would attach more importance at this point to the working capital management than further reductions in capex.\n\nChip Moore -- EF Hutton -- Analyst\n\nGot it. Okay. That makes sense. And just last one for me. Just curious on Nuvera, if anything's changed materially from the last quarter, right? We were talking about accelerated commercialization efforts, developing the new larger engine. Just, I guess, when we might expect to take some traction on the bookings front, any insights there?\n\nRajiv K. Prasad -- President\n\nSo Nuvera, again, let's just take our -- what we're doing with our own fuel cell programs as an example of what's happening. So what we -- as you know, we got some fuel cells in the marketplace as what we call battery box replacement for BBRs. And we've gained a huge amount of feedback on the performance of those in the field, and we've improved the robustness of our solutions using that data. So that's one thing. We've learned a huge amount.\n\nThe second thing is we're applying -- we think the future for us is an integrated fuel cell in our trucks. And we're starting with our bigger trucks. So first quarter -- well, early in 2023, we're working on having a complete solution for ports, which will be fuel cell based. We'll have a terminal tractor, which we are developing jointly, which we've announced. We'll have our reach stackers, the top pits, and empty container handlers.\n\nSo these are the biggest trucks we make for port applications. They'll all have fuel cell systems integrated into them. So that's where the internal focus is. And basically, external developments are taking similar time. It takes a little bit of time with the Nuvera customers to demo the product, develop prototypes, test the prototypes, and then release the product.\n\nWhat we are focused on are segments that we believe could benefit from fuel cell in the early stages of this market development. And those are typically the heavier beauty applications on the trucking side, for instance. So we talk about refrigerated trucks or refuse trucks. So products like that, where we don't think if you electrify them, the battery solution will work very well. So that's the focus that Nuvera is kind of moving forward with. And those are the markets that they're discussing with, and we'll talk more about that in the future.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nI would only add to that to amplify that the need for electrification in these heavy-duty segments appears to be quite broadly understood. What isn't so well understood by the potential builders and users of those vehicles is that pure battery solutions are unlikely to work effectively and productively in a significant portion of those heavy-duty applications.\n\nSo rather than offer focus on sort of broad, very, very long term solutions, we're trying to focus on ones where we think that there's very limited battery electrification solution available and where our fuel cells will really be the right way to fill the gap as they move to a non carbon solution. I hope that helps you.\n\nRajiv K. Prasad -- President\n\nAnd again, we'll talk about this more in the future as things solidify.\n\nChip Moore -- EF Hutton -- Analyst\n\nNo, makes a lot of sense. I agree with that. Thank you.\n\nOperator\n\nThank you. Your next question comes from the line of Steve Ferazani from Sidoti & Company. Please proceed with your question.\n\nSteve Ferazani -- Sidoti & Company -- Analyst\n\nHi, everyone. I just want to ask about -- I'm looking at the volatility numbers, which clearly are improving sequentially. Revenue was up even though it's usually a seasonally weaker European quarter, given its larger European exposure. And the margin is not that bad given material prices and freight costs. Is it simply the answer that it's doing better simply because less components, less complexity? Or is there something else that worked?\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nI think the main thing that's at work is that the cycle time is much shorter. So Rajiv, the time from order to delivery would be --\n\nRajiv K. Prasad -- President\n\n6 to eight weeks.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nJust six or eight weeks where it could be six or eight months from a forklift truck. So they have the ability to respond to price material cost and freight cost increases much more rapidly than the forklift truck business does.\n\nRajiv K. Prasad -- President\n\nI mean I think the really great situation for Bolzoni is the huge amount of backlog, not just we have but competitors have too in the marketplace. We expect significant shipments in 2022. And the order for attachment will probably come six to eight weeks before the delivery of the truck, not when the trucks were booked. But to a certain extent, our backlog is showing Bolzoni, the potential, the market potential, and we're very excited at Bolzoni about what will happen in 2022 and going into 2023. A very positive market for that.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nWhen you combine that sort of broad market perspective with the initiatives that Rajiv outlined in his strategic summary. He focused on one company activities with a particular emphasis on industry strategy work and the enhancement of our delivery capabilities in North America. We think we have a very powerful engine going there.\n\nSteve Ferazani -- Sidoti & Company -- Analyst\n\nWe have talked about lead times and how it affects orders. I'm sort of getting two different answers on that [Indecipherable] cause every company's been going through backlog and what seems spending lead time. Some would say spending lead time is a deterrent but others are saying that they're seeing more orders. People know they're going to be just long a wait and are already looking that far ahead perhaps in thriving order intensity. I want to hear your thoughts.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nYeah, I think generally if we take this at a step back and think about the dynamics of the current market at the moment. But ultimately, we believe that a shorter lead time is better for everyone. Better for us, better for the market, better for our customers. But you're right, the current situation is basically getting customers to book ahead and we're seeing that, and that you can see last quarter, we had very large backlog and you can see we have even bigger backlog now because customers want to make sure that they have slots in the queue for their need. And as you say, it's not just us that have the long lead time but all of our competitors and industry in general.\n\nSo there is a significant amount of booking ahead going on because as you see, we are not getting any cancellations because of the long lead time. So I think it is a transition situation. We would like to get back to build through the backlog and get back to the more normal lead times. That's our primary mission.\n\nChip Moore -- EF Hutton -- Analyst\n\nAs you think about that and it's worth hearing about supply chain issues intensifying, not easing, and that's the duration perhaps expands. Does that -- and you've addressed it a lot, but I'm just trying to think through work arounds and ability to deal with something that clearly has grown in the intensity as the year has gone on. And certainly no one's talking transitory anymore.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nRight. Let me just give a very broad based answer to that. I don't think people in general whether it's the government or companies broadly and the public have internalized the degree to which consumer demand has increased during the COVID period over and above the level of demand in 2019. Not 2020, because that was COVID influence. But if you look at today, we had a huge increase in total demand, but it shifted. Restaurants, travel, entertainment have all gone way down. Goods have gone way up and so the [Indecipherable] change with a huge pent up demand. People have had a generous benefits that they save rather than spend. And so if you have the end product demand for consumption by U.S. consumers or consumers around the world in goods, then you got to look at the whole supply chain structure and what end up claiming is that everything is out of capacity. It's the supplier's capacity, the commodity producer's capacity. We've heard a lot about chemicals. You're hearing daily about chips. All of these are the result of this very substantial increased demand. And I think people have been, if you will, sort of not thinking carefully enough about the impact on the margin from a mismatch between supply and demand.\n\nDemand is high and supply is lower than demand. What you can get, in many cases, particularly commodities, and certainly now in shipping, is the kind of cost increase that it's not marginal. It's not small to reflect a small imbalance. It becomes a bidding contest between those who really, really want to have the space on ships and those who just can't afford or see that opportunity.\n\nSo it's a very broad-based issue that's coursing through the economy and the world in a way in terms of commodity development. So I think that's really the backlog. And one of the questions then is, will that demand mix shift be sustained. I think that's partly the $64 question here because it's going to take time to break all of the supply chain constraints. You've heard about chip manufacturing. It's going to take a couple of years to bring new chip fab operations on stream.\n\nAnd so what we forecast is a decline in the market compared to the last couple of years in 2022 because we think that there's going to be some kind of shift back as COVID moderates toward more expenditures on travel and entertainment, and so on and so forth. So that's kind of a very broad overview, but I think it captures the dynamics. And you miss that when you just focus on what's going on in the lift truck business.\n\nChip Moore -- EF Hutton -- Analyst\n\nThat's fair. Appreciate the thoughtful answer. Thanks everyone.\n\nOperator\n\n[Operator Instructions] Your next question comes from the line of Brett Kearney from Gabelli Funds. Please proceed with your question.\n\nBrett Kearney -- Gabelli Funds -- Analyst\n\nHi guys, good morning. Thanks for taking my question. So it sounds like increasing product demonstrations at Nuvera, which is encouraging. I was curious how much of that is based around the new test facility you've been able to establish in Italy? And whether there's thoughts on similar establishments in some of the other geographic markets. It sounds like there's more interest in North America.\n\nAnd I guess tied to that, it sounds like the China bus market proceeding a little bit slower than initially anticipated. Just strategically, how you're thinking about resources and allocating them at Nuvera going forward?\n\nRajiv K. Prasad -- President\n\nI think the first thing to say, the interest in fuel cells is increasing. And if I just characterize it, what's happening in China is there is a transition and it's government-led from thinking about buses for fuel cells to trucks. Trucks are becoming much more important for fuel cell application in China.\n\nIn Europe, thinking of -- really starting to understand fuel cell as a long-term solution for mobility is gaining huge momentum. There's a large amount of programs, government-sponsored programs being put in place. And then some of the regions in North America, particularly California and some of the East Coast geographies are starting to see that also. So overall, there's been a much more interest and understanding that fuel cell is a critical part of our electrification journey as we move forward.\n\nThe second area is if we think about where the applications are, people are starting to think about applications in phases. So the initial phases has been truck -- vehicles that are captive to a depot, let's say. So forklift trucks fit that category because of fueling. So hydrogen can be made available in a depot and that can support vehicles.\n\nAnd we think that will go from forklift trucks to delivery trucks to -- I gave example, refuse trucks. We think airports are a good example. So we think the next phase is going to be these captive vehicles, and that's where Nuvera is focused right now -- terminal tractors and the various types of trucks we've defined.\n\nPhase three then is going to be trucks that are much more regional. So not long-haul trucks, but maybe regional haul trucks, that's the next area for them. So we see this evolution, and that's the engagement we're getting with customer base both in Europe and in North America. And of course, we've already had our engagement in China forward.\n\nWhat is taking time is developing these trucks because a lot of the customers have a huge amount of experience in internal combustion engine, but electrifying those trucks and then adding fuel cells to it and create a robust solution is taking time, which it is also for our own internal solutions for lift trucks.\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nLet me add to that a little bit that. To the thrust of your question, the sort of prospects in the three big areas of the world for fuel cells, China, North America, and Europe have really readjusted significantly.\n\nIf you think about China, one of the complexities that's become very, very clear in the last few months is, and particularly in the very recent period, is that in a highly regulated economy subject to Chinese, the priorities can change very, very fast. And the priorities are significantly backed up by subsidies and incentives.\n\nAnd so when we entered into the commercial arrangements that we had in China, and there were two major ones, the expectation was that the regulatory environment was going to make those very, very attractive on a broad basis. That's the only reason that we invested in the inventory and in the equipment. We have now, as you noted, reduced the value of both of those. But I would point out that inventory is perfectly good. It just can't be used up in the near-term because we're not likely to have the sales.\n\nBut it will be sold at the reduced cost. It should be -- very, very little of both the equipment and the inventory is not usable from our point of view. So we are certainly concentrating on building -- on gaining the business for those. But we're being very careful now to have contracts in China that are much more -- have far more teeth in them and less opportunity to delay as government incentives change.\n\nBut I think the bottom line is the Chinese market for us has declined as a focal point relative to Europe and the Americas. And in fact, in Europe, we see significant opportunities. It's a different kind of regulatory environment in Europe. It tends -- when it does get put in place, not to change. They're pro-addressing climate change in Europe.\n\nWe see significant opportunities, and we're going to be working to focus on that, probably far less in the forklift truck business and far more in the -- in some of these segments that Rajiv outlined. And we think that in the United States, that the push for electrification is going to force the use of fuel cells in the kinds of applications that I described earlier.\n\nSo in total, it's a rather fundamental rebalance in the likely prospects between the three major areas of the world in terms of near-term market development. They're all going to be important. We're going to play in all of them, but we see different emphasis right now.\n\nBrett Kearney -- Gabelli Funds -- Analyst\n\nYes, OK. That's very helpful. Thank you. And then maybe just one other quick one, probably for Ken. You guys were proactive, able to complete that refinance back in Q2. And just curious, whether I have it right, is there a restriction on dividends from a covenant standpoint? Could you just maybe remind me of the financial covenant package included in that covenant agreement?\n\nKenneth C. Schilling -- Senior Vice President and Chief Financial Officer\n\nYes. We have the ability, as long as we maintain adequate availability as specified in the agreement, to continue to pay dividends to continue to move forward. And our goal is to maintain within those restrictions on availability to manage through the situation. With the increase in the term Loan B and the larger ABL, we did that to not only help us with the seasonal nature of our increased sales that we expected, but also to help us weather through this -- the unexpected volatility in material pricing and material availability as well as logistics.\n\nSo it was sized to consider those issues. We're continuing to work through that. And again, we'll manage to availability. The springing fixed charge isn't something that we're relying upon.\n\nBrett Kearney -- Gabelli Funds -- Analyst\n\nOkay, terrific. Very helpful. Thanks so much.\n\nOperator\n\nThank you. There are no further questions on queue. I will now turn the call back to Christina. Now, please go ahead.\n\nChristina Kmetko -- Investment Relations\n\nThank you. That will conclude our Q&A session. Al, do you have any final closing comments?\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nThere's no final comments.\n\nChristina Kmetko -- Investment Relations\n\nOkay. Thank you. We'll close with just a few final reminders. A replay of our call will be available online later this morning. We'll also post a transcript on the Investor Relations website when it becomes available. If you have any questions, please reach out to me. You can reach me at the number on the press release. I hope you enjoy the rest of your day. I will now turn it back to the operator to conclude the call.\n\nOperator\n\nThank you, Christina. Once again, as a reminder, the encore replay will be available approximately two hours after the conclusion of this call. You can dial out 800-585-8367 or 416-621-4642 until November 10, 2021, at 11:59 p.m. Eastern Time. Conference ID number is 4694252. Thank you for your participation. You may now disconnect.\n\nDuration: 55 minutes\n\nChristina Kmetko -- Investment Relations\n\nAlfred Marshall Rankin -- Chairman and Chief Executive Officer\n\nRajiv K. Prasad -- President\n\nKenneth C. Schilling -- Senior Vice President and Chief Financial Officer\n\nChip Moore -- EF Hutton -- Analyst\n\nSteve Ferazani -- Sidoti & Company -- Analyst\n\nBrett Kearney -- Gabelli Funds -- Analyst\n\nMore HY analysis\n\nAll earnings call transcripts\n\n"}
{"id": "0086ee6a-e797-47b2-b4b4-dd672540ea2c", "companyName": "Chimera Investment", "companyTicker": "CIM", "quarter": 4, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/02/17/chimera-investment-cim-q4-2021-earnings-call-trans/", "content": "Chimera Investment\u00a0(CIM -1.62%)\nQ4\u00a02021 Earnings Call\nFeb 17, 2022, 8:30 a.m. ET\n\nOperator\n\nLadies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation fourth quarter and full year 2021 earnings conference call. [Operator instructions]. It is now my pleasure to turn the floor over to Victor Falvo, head of capital markets.\n\nVictor Falvo -- Head of Capital Markets\n\nThank you, Ashley, and thank you, everyone, for participating in Chimera's fourth quarter and full year 2021 earnings conference call. Before we begin, I'd like to review the safe harbor statements. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties, which are outlined in the risk factors section in our most recent annual and quarterly SEC filings.\n\nActual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings. During the call today, we may also discuss non-GAAP financial measures. Please refer to our SEC filings and earnings supplement for reconciliation to the most comparable GAAP measures.\n\nAdditionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information. I will now turn the conference over to our CEO and chief investment officer, Mohit Marria.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nThank you, Vic, and good morning, and welcome to the fourth quarter and full year 2021 earnings call for Chimera Investment Corporation. Joining me on the call today are Choudhary Yarlagadda, our president and chief operating officer; Subra Viswanathan, our chief financial officer; and Vic Falvo, our head of capital markets. After my remarks, Subra will review the financial results, and then we will open the call up for questions. Low interest rates throughout most of 2021, combined with strong investor demand for high-quality fixed income assets allowed Chimera to optimize its liability structure, which we believe will benefit our shareholders over the long term.\n\nSecuritization of mortgage assets is at the core of our company's DNA and is paramount to Chimera's market differentiation among its peers. Through innovative structuring techniques, we have consistently demonstrated our ability to efficiently manage our portfolio's asset and liability risk while maintaining low recourse leverage and attractive net interest spreads. The reperforming loans we purchased in the period from 2016 to 2018 have generated portfolio yields that have exceeded our original expectations. Our resecuritization activity in 2021 enabled us to refinance the debt on these loans with a interest expense as well as release equity from the original purchases.\n\nFor the full year 2021, we refinanced 13 of our previously issued reperforming deals, with eight new securitizations on $6 billion of mortgage loans. Higher advance rates achieved through Chimera's resecuritization activity in 2021 freed up more than $900 million of capital and helped us accomplish many objectives toward the strengthening of our balance sheet. Lower interest expense and higher advance rates on our 2021 securitizations have provided a great benefit to our asset and liability structure. It positively impacted the returns on our newly retained investments and allowed us to further shift financing from recourse to nonrecourse, a clear enhancement for the long term.\n\nThe results of our work in 2021 helped reduce the amount of recourse financing on our credit assets by over 800 million, while significantly lowering the interest expense on our credit-related repo. In addition, we successfully paid off 400 million high-cost debt plus the associated warrants and extinguished the remaining 50 million of convertible debt. Overall, securitized debt represents 70% of our total financing, up from 65% in 2020. Our cost of securitized debt was 2.40% at year-end, a 120 basis point reduction from 2020.\n\n98% of our securitized debt has a fixed rate coupon, which is important as interest rates have begun to rise. The fixed rate accreted on our deals helped to lock in a wide net interest spread and our securitized assets for a long period of time. Most of our securitizations are structured with explicit call dates. We called 13 deals in 2021 and have 14 deals callable in 2022.\n\nAnd our entire stack of securitized debt has a weighted average time to call of three years. These call days provide opportunities to frequently optimize our funding structure, which has proven to be immensely beneficial. Now I would like to take you through our asset purchases and fourth quarter securitization activity. In the fourth quarter, we purchased 540 million of reperforming loans.\n\nWe closed on 100 million of the loans in December and expect 440 million of these loans to close in the first quarter of 2022. For the full year 2021, we purchased over 3.2 billion in loans, consisting of 1.3 billion in reperforming loans, 320 million of business purpose loans, 1.2 billion in prime jumbo loans, and 435 million of agency-eligible investor loans. For securitization activity in October, we securitized 354 million CIM 2021-R6 with reperforming loans from our loan warehouse. We sold 336 million in notes, representing a 95% advance rate, the highest advance rate we have achieved on reperforming loans to date.\n\nThe average cost of debt for the R6 deal is 1.53%. Chimera retained an $18 million investment in subordinate notes and interest-only securities. The R6 deal was rated by Fitch and DBRS and will be callable beginning September of 2026. In November, we completed our 14th and final securitization of the year.\n\n168 million CIM 2021-NR4 with nonperforming loans from our warehouse. We sold 126 million senior securities, representing 75% of the capital structure. We retained 42 million in subordinate notes for investment. 2021 was the most active year for securitization in Chimera's history.\n\nIn total, Chimera sponsored $8 billion in 14 separate securitized deals, six reperforming loan securitizations; four nonperforming loan securitizations; three prime jumbo securitizations, and one agency-eligible investor loan securitization. The reperforming and nonperforming deals have been consolidated on our balance sheet. The prime jumbo and the agency-eligible loans are not consolidated on our balance sheet. As we begin 2022, we are well-positioned for the current market environment with higher rates and wider spreads.\n\nOur balance sheet is strong with 95% of the capital allocated to residential mortgage credit. 70% of our financing is securitized debt, which we believe provides optimal long-term nonrecourse financing for our loan portfolio. Our net interest spread is strong, largely resulting from the reduction in financing cost this past year, and our leverage is at historically low levels. We have accomplished a lot this year.\n\nOur securitization business remains strong. We have ample cash on hand to grow the portfolio. And as we embark on 2022, we're set to continue to deliver the best risk-adjusted dividends to our shareholders. I will now turn the call over to Subra to review the financial results.\n\nSubra Viswanathan -- Chief Financial Officer\n\nThank you, Mohit. I will review Chimera's financial highlights for the fourth quarter and full year 2021. GAAP book value at the end of the quarter was $11.84 per share, and our economic return on book value was negative 1.2% based on quarterly change in book value and the fourth quarter dividend per common share. Our economic return for the full year was 6.2%.\n\nGAAP net loss for the fourth quarter was 718,000 or zero per share and GAAP net income for the full year was 596 million or $2.44 per share. On an earnings available for distribution basis, net income for the fourth quarter was 111 million or $0.46 per share and 429 million or $1.78 per share for the full year. For onetime nonrecurring items, we had approximately $0.08 of income that was derived from securities called during the quarter and $0.26 of income that was derived from securities called over the full year. While this may occur from time to time, we don't expect this level of income every quarter.\n\nAnd in some quarters, we could have a loss related to interest-only securities that are called. We will provide details on this income whenever it becomes material to our earnings available for distribution. Our economic net interest income for the fourth quarter was 155 million and 630 million for the full year. For the fourth quarter, the yield on average interest-earning assets was 6.4%.\n\nOur average cost of funds was 2.3%, and our net interest spread was 4.1%. Total leverage for the fourth quarter was three to one while recourse leverage ended the quarter at 0.9 to one. For the year, our economic net interest return on equity was 16.5%, and our GAAP return on average equity was 18.1%. And lastly, our full year 2021 expenses, excluding servicing fees and transaction expenses, were 69.1 million, in line with previous year.\n\nThat concludes our remarks. We will now open the call for questions.\n\nOperator\n\n[Operator instructions]. And we will take our first question from Bose George with KBW. Please go ahead.\n\nMike Smyth -- Keefe, Bruyette and Woods -- Analyst\n\nThis is actually Mike Smyth on for Bose. My first question, in your prepared remarks, you mentioned your most recent RPL deal with the 95% advance rate. Just wondering what's the all-in ROE on that deal? And then would you ever hold any repo against that as well? Or do you get a high enough unlevered ROE on the supportive fees?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nMike, this is Mohit. How are you? The question as it relates to the 2021-R6 deal, as mentioned in the opening remarks, we did hold an 18 million investment, plus the derivatives that were created. And the returns on the sub stack and the IOs will produce very high single digits, low double-digit deals, depending on the type of financing that we could get on the sub stack, we could potentially repo it. But at the moment, it's held for cash.\n\nAs we've highlighted on previous calls, the composition of the financing on the retained pieces. We would prefer non-mark-to-market than longer tenure. So if that becomes available and seems attractive, we could potentially add that in the future.\n\nMike Smyth -- Keefe, Bruyette and Woods -- Analyst\n\nThat's helpful color. And we have heard that volatility has picked up a bit in the securitization markets over the last few weeks. Just curious to hear your thoughts on that and how long you expect any volatility to persist for?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nYes. I mean we have seen an uptick before, and we thought typically the January effect of bringing buyers it has, but the amount of deal flow has definitely been elevated. A lot of the volatility is on the prime jumbo and the non-QM side. The season reperforming securitizations are few and far between even in the last year outside of us and a handful of other issuers.\n\nSo again, I think the rate volatility, the backdrop of what's happening, macro event has led to buyers being more selective. And I think the large amount of deal volume in the first six weeks has also put a lot of pressure on spreads in the near term. But we think it will stabilize with housing still remaining strong and yields on these assets on these new deals that you couldn't get a year ago, still is an attractive place to park money. So we're still optimistic.\n\nAs mentioned in the opening remarks, we have 14 deals that are callable over the year, and we will see how the market is as we sort of take advantage of that as we did last year.\n\nMike Smyth -- Keefe, Bruyette and Woods -- Analyst\n\nGreat. That's helpful. And then just one more for me. Have -- I guess as a follow-up.\n\nHave you seen any changes in loan prices to reflect the wider spreads in the securitization market?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nThe loan pricing has been more sticky than where execution is occurring in the new issue space. But again, I think with just the backup in rates, the translation on the new issue side, whether it be prime jumbo, agency-eligible investor or non-QM, we felt more of a spread widening there on the loan front. Again this RPL space, the main sellers there remain the GSEs. There are some funds that we'll liquidate, and what we've seen so far this year, pricing is marginally wider but not significantly wider unlike the prime jumbo and non-QM space.\n\nMike Smyth -- Keefe, Bruyette and Woods -- Analyst\n\nGreat. That's helpful. Thank you for taking the questions.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nThank you, Mike.\n\nOperator\n\nAnd we'll take our next question from Eric Hagen with BTIG. Please go ahead. Your line is open.\n\nEric Hagen -- BTIG -- Analyst\n\nHey, guys. Good morning. Maybe a couple for me. For the 108 million in unrealized losses for the period, can you give some color on where those marks were concentrated? And then you obviously mentioned the callable securitized debt, which remains a focal point of the portfolio.\n\nCan you talk about how you guys think about the trade-off between potentially higher funding costs as those deals come up for call and the ability to get more leverage and restructure your advance rate and such? Thanks.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nSure, Eric. I'll start with the second part of the question, and Subra can give some color on the first part as it relates to the unrealized losses due to fair value changes. The balance between -- or the economics, I should say, looking at calling a deal versus not calling a deal are twofold, and you highlighted the two things. One is if there's a reduction in the all-in financing cost; and two, if the structural leverage is not optimal and we could optimize it via the call and take out some equity as -- those are the two things we look at any time we make a call.\n\nFor the calendar year 2021, we had the benefit of being able to do both, reduced financing costs quite significantly while also achieving a higher advance rate leading to an equity lease of over 900 million. If you look at the deals that are in the supplement on the last page, the 14 deals have delivered quite substantially. So no doubt based on the strong securitization market, strong housing, and strong credit performance of those deals. We should be able to attain a similar advance rate as we did on the securitizations we did in 2021.\n\nSo that's the first factor. And given the time frame in which those deals were executed, if you go back to 2018, '19, the rates were obviously higher than they are today. So in some cases, you may still have a cost savings. But being able to take out equity in a rising rate environment with wider spreads should still give us the ability to take advantage of redeploying new capital into new assets.\n\nSo hopefully, that answers your question there. As far as the fair value, I'll let Subra touch upon that on the breakdown of that.\n\nSubra Viswanathan -- Chief Financial Officer\n\nThanks, Mohit. On the securitized loans, we saw about 92 basis points of reduction or unrealized losses. The non-AC senior debt -- the non-AC senior securities positions, we saw about 2.34% drop. And on the securitized debt, which was our liabilities, we saw 114% -- a 114 basis point drop.\n\nSo that's the breakout.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nA lot of our legacy assets are obviously rolled down the curve quite significantly and the move in rates in Q4 was more front-end loaded. The tenure was effectively flat quarter-over-quarter. So that change in rates is what led to some of our legacy assets pricing going down for the quarter, Eric.\n\nEric Hagen -- BTIG -- Analyst\n\nThat's helpful. That's helpful. And then on the securitized debt that is up for call this year, can you say what the fixed rate coupon is on the debt that is potentially rolling over?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nI don't have that number here in front of me, but we could get that number for you guys. I think it should be in the financials. I just don't have that here in front of me.\n\nEric Hagen -- BTIG -- Analyst\n\nYes. Thank you very much. Appreciate it.\n\nOperator\n\nWe have our next question from Kenneth Lee with RBC Capital Markets. Please go ahead. Your line is open.\n\nKenneth Lee -- RBC Capital Markets -- Analyst\n\nHi. Thanks for taking my question. You touched upon this briefly, but just wondering if you can just further elaborate about your expectations around expected returns on the retained tranches for any of the resi mortgage loans in the current environment? Thanks.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nSure. Ken, as it relates to 2021, the levered returns on what we created are very high single digits to low double digits on a -- just a loss-adjusted basis and implying some leverage depending on the format comes in, those returns could be high double digits, between 17 to 18%, depending on, again, the leverage you embed on those. As we look forward, obviously, there's been some more volatility in the new issue market. I guess, primarily on the prime jumbo and non-QM side.\n\nBut that should also put pressure on loan pricing, although it hasn't been reflected yet, but we think those two things should move in tandem and your returns on retained pieces even this year should produce pretty attractive risk-adjusted returns in the same context as last year.\n\nKenneth Lee -- RBC Capital Markets -- Analyst\n\nGot you. Very helpful. And then one follow-up, if I may. Just given the current environment and obviously, the macro backdrop how would you characterize your current investment stance? Or in other words, do you expect leverage to sort of like remain at the same levels or could you get a little bit more on the offense going forward as pricing gets a little bit more attractive potentially? Thanks.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nThat's a good question, Ken. Thank you. As we've highlighted on pretty much all of the calls last year, we played defense just with the uncertainty around what the Fed may do, the pandemic and how long that will go on for. And have had still a very successful year in accomplishing and buying $3.2 billion of loans, which are accretive to the portfolio.\n\nAs we sit here with 0.9 turns of recourse leverage and ample liquidity at our disposal, we actually want to take off -- take the offensive here, whether it be on the agency side, given the spread widening and more clarity from the Fed unwinding paring down their activity. What's happening in the new issue market, which should lead to some widening on loan spreads. So I think we are actually very well-positioned to take advantage of all of those investment opportunities that may become available. And I think we will look to take leverage up from where we are at 0.9% higher and take advantage and grow the portfolio here.\n\nKenneth Lee -- RBC Capital Markets -- Analyst\n\nGreat. Very helpful. Thanks.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nThank you, Kenneth.\n\nOperator\n\nWe'll take our next question from Trevor Cranston with JMP Securities. Please go ahead. Your line is open.\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nThanks. Good morning. You guys mentioned the sort of change in pricing you've seen in the -- primarily in the prime jumbo and the non-QM spaces in 4Q and in the first quarter. Can you also talk about any changes you've seen in terms of the supply of loan products available for sale with the uptick in volatility in the first quarter and how you expect that piece to play out over the course of the year?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nSure, Trevor. I'll take this one. As far as the prime jumbo and non-QM stuff goes, I think from an originator standpoint, we are going to see more activity there just for them to continue churning, if you will, their origination channels and this infrastructure they have built. So I think we will have ample opportunity to buy as much as we want of that product.\n\nI don't think -- to the extent the economics return to make sense, we will sort of grow that. We did a total of four securitizations on new issue collateral, three jumbo, and one agency-eligible investor. On the RPL side, I guess a lot of that flow is primarily coming from the GSEs. They target anywhere between 12 to $18 billion of loan sales a year.\n\nWe will see what their calendar looks like for 2022. We did get the first announcement from Fannie last week about their upcoming sales. So we think, again, that supply will be more controlled by the GSEs, and we'll keep that market, at least from a spread perspective, more controlled than some of the other markets, which are just bringing deals to the market to mitigate some of the rate risk and how much the rates have moved in the first six weeks of this year.\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nGot it. OK. That's helpful. And then given the magnitude of the move in rates and some credit spread widening we've seen in the first quarter, do you guys have an estimate as to how your book values moved since the end of the year?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nSure. I think our approximate change in book value since the start of the year is around 2.5%.\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nSo up 2.5%, just to be clear.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nDown 2.5%, I'm sorry.\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nDown 2.5. OK. Got you.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nDown 2.5%\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nSure. OK. Thank you.\n\nOperator\n\nWe'll go next to Doug Harter with Credit Suisse. Please go ahead. Your line is open.\n\nDoug Harter -- Credit Suisse -- Analyst\n\nThanks. Just, Mohit, as you're looking at the opportunity set, can you just talk about the relative attractiveness of legacy versus new production versus agency? And how -- as you look to get a little bit more offensive as you said, kind of how you would look to allocate across those opportunity sets?\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nSure, Doug. I'm assuming when you say legacy, you mean legacy loans, not necessarily legacy securities. So on the loan front, I think, again, given the rate environment we're in, Convex is going to play a bigger role this year than in prior years. So having 170-month season loans and knowing how those loans are going to prepay and behave is going to be a lot more telling.\n\nThat remains a big focus for us. We were successful in adding $1.2 billion of those loans last year. We're hopeful from the GSEs this year that we'll have more success as far as new originations go. I think the volatility will create opportunities for us to add loans there as well.\n\nBut a lot of that will be subject to where the securitization exits are on those loan purchases and what the retained pieces look like. So as we've always done, that will drive our decisions on the way we sort of commit capital. And obviously, some of the low-level adjustments that the GSEs have made at the start of this year should also lead to a larger private label exit for some of these originators. But we just need the market to stabilize on the new issue side, on the securitization side for that -- for us to be able to take advantage of that.\n\nAnd if you look at more broadly the agency space where we really haven't had any agencies since March of 2020, we've seen a 25 to 30 basis point widening of the basis so far since the Fed announcement. We think those could widen out a little bit more. But again, as we look at it, the all-in yields that are attainable today are probably at the levels last seen in 2019. So we do think it does make relative value sense to deploy some capital there over the course of this year, and we'll be patient in sort of taking advantage of those opportunities.\n\nOperator\n\nAnd there are no further questions at this time. I will now turn the call back over to Mohit for any closing remarks.\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nThank you, Ashley, and thanks, everyone, for joining us today. We look forward to speaking to you on our Q1 call.\n\nOperator\n\n[Operator signoff]\n\nDuration: 26 minutes\n\nVictor Falvo -- Head of Capital Markets\n\nMohit Marria -- Chief Executive Officer and Chief Investment Officer\n\nSubra Viswanathan -- Chief Financial Officer\n\nMike Smyth -- Keefe, Bruyette and Woods -- Analyst\n\nEric Hagen -- BTIG -- Analyst\n\nKenneth Lee -- RBC Capital Markets -- Analyst\n\nTrevor Cranston -- JMP Securities -- Analyst\n\nDoug Harter -- Credit Suisse -- Analyst\n\nMore CIM analysis\n\nAll earnings call transcripts"}
{"id": "009cf8b5-5829-4084-a0b9-472f3cae8b13", "companyName": "DHT Maritime", "companyTicker": "DHT", "quarter": 2, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/11/dht-maritime-dht-q2-2022-earnings-call-transcript/", "content": "DHT Maritime\u00a0(DHT 5.08%)\nQ2\u00a02022 Earnings Call\nAug 11, 2022, 8:00 a.m. ET\n\nOperator\n\nGood day, and thank you for standing by. Welcome to the Q2 2022 DHT Holdings, Inc. earnings conference call. [Operator instructions] I would now like to turn the conference over to your speaker today, Laila Halvorsen.\n\nPlease go ahead.\n\nLaila Halvorsen -- Chief Financial Officer\n\nThank you. Good morning, and good afternoon, everyone. Welcome, and thank you for joining DHT Holdings' second quarter 2022 earnings call. I am joined by DHT's president and CEO, Svein Moxnes Harfjeld.\n\nAs usual, we will go through financials and some highlights before we open up for your questions. The link to the slide deck can be found on our website, dhtankers.com. Before we get started with today's call, I would like to make the following remarks. A replay of this conference call will be available at our website, dhtankers.com, until August 18th.\n\nIn addition, our earnings press release will be available on our website and on the SEC EDGAR system as an exhibit to our Form 6-K. As a reminder on this conference call, we will discuss matters that are forward-looking in nature. These forward-looking statements are based on our current expectations about future events as detailed in our financial report. Actual results may differ materially from the expectations reflected in these forward-looking statements.\n\nWe urge you to read our periodic report available on our website and on the SEC EDGAR system, including the risk factors in this report for more information regarding risks that we face. The company continued to show a very strong and healthy balance sheet, and the quarter ended with 106 million of cash. At quarter end, the company's availability under both revolving credit facilities was 188 million, putting total liquidity of 294 million as of June 30th. Financial leverage is about 28% based on market values for the ships.\n\nAnd net debt per vessel was 15.7 million at quarter end, which is well below current scrap values. Looking at the P&L highlights, EBITDA for the second quarter was 32.5 million. And net income came in at 10 million equal to $0.76 per share. The result includes the gain related to sale of vessels and a noncash gain in fair value related to interest rate derivatives.\n\nThe company continues to -- continues with a good cost control with opex for the quarter at 18 million, equal to $7,800 per day and G&A for the quarter at 4.2 million. In the second quarter, the company achieved an average TCE of $24,300 per day with a vessel's time charter earning $33,800 per day, and the vessels in the spot market earning $21,200 per day. For the third quarter, 68% of the available days have been booked at an average rate of $23,600 per day. And 58% of available spots have been booked at an average rate of $18,400 per day.\n\nWe sold two vessels during the quarter, DHT Hawk and DHT Falcon, for 40 million and 38 million, respectively. The sales generated a combined gain of 12.7 million. In connection with the sales, we repaid outstanding debt on the two vessels of 13.3 million. Both vessels were delivered during the second quarter, and net proceeds amounted to 62.9 million.\n\nFollowing these sales, the average age of our fleet has been reduced and our AER and EEOI metrics improved. Part of the net proceeds were used to reduce debt. In June, we prepaid 23.1 million under the Nordea credit facility. The voluntary prepayment was made under the revolving credit facility tranche and may be reborrowed.\n\nOn the next slide, we present the cash bridge for the quarter. We started the quarter with 58.6 million of cash which generated 32.5 million in EBITDA. Ordinary debt repayment and cash interest amounted to 9.1 million, while 19.2 million was allocated to shareholders through share buybacks and dividend payment; $4.5 million was used for maintenance capex following net proceeds from the sale of vessels amounted to 62.9 million; 23.1 million, as was mentioned on the previous slide, used to prepay long-term debt; 8.3 million was the initial cash recognition from [Inaudible]; and we ended the quarter with 105.8 million of cash. Switching now to capital allocation.\n\nDuring the second quarter, the company purchased 2.8 million of its own shares, equal to 1.7% of the outstanding number of shares as of March 31st for an aggregate consideration of 15.9 million. In addition, the company will pay a dividend of $0.04 per share for the quarter. It will be payable on August 30th to shareholders of record as of August 22. This marks the 50th consecutive quarter cash dividend.\n\nWith that, I'll turn the call over to Svein.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThank you, Laila. Following the share repurchases conducted during the second quarter, as discussed by Laila, we continue to buy back stock after the quarter end under the 10b5-1 rule. Our third quarter to date acquired 1.5 million shares at an aggregate cost of 8.8 million at an average price of $5.87 per share. Considering buybacks conducted in 2021 and buybacks made year to date, we have in total bought back close to 10 million shares, equaling some 6% of the company's capital.\n\nWith a total consideration of 57 million, the average price of these repurchases is $5.77 per share. We consider this to be a great and an accretive investment. And all shares have been retired upon receipt. During the quarter, we agreed to refinance the bilateral credit facility for the DHT Tiger with the existing lender, Credit Agricole.\n\nThe structure is in line with the DHT's fund financing; 37.5 million made up of 2.5 million per year of the remaining life of the ship. It has six-year tenor and 20-year repayment profile. The pricing represents a new low for DHT's borrowing cost at the secured overnight financing rate, also referred to as a SOFR, plus a margin of 2.05%. It includes a historical credit adjustment spread of 26 bps between SOFR and LIBOR, as this is a new structure that will replace LIBOR.\n\nYou should note for reference that this pricing is equal to or LIBOR plus a margin or 179 bips. We typically have a mix of spot and fixed employment for our fleet. However, it is not formulaic with the percentage of the fleet employed one way or another but the focus on the nominal rates and tenors that, in our view, will contribute meaningfully to the business. We have entered into a five-year time charter for the DHT Osprey at $37,000 per day.\n\nDelivery is planned for August, and the customer has options to extend for an additional two years at 40,000 and 45,000 per day, respectively. The key attraction to this time charter is the tenure, as we would not find this rate attractive for a two or three-year charter. We see an increased level of inquiries for time charters and will selectively engage with our customers, if and when meaningful business can be conducted. We have committed 25 million to retrofit our additional 8 ships with scrubbers.\n\nThe combination of decreased scrubber costs, early delivery of equipment, and continued elevated spreads between heavy fuel oil and very low-sulphur fuel oil makes this a compelling investment in our view. Considering the current average spreads in Fujairah & Singapore, the payback on these investments should be inside a year. The work will commence in the fourth quarter, and we expect completion during the first quarter of next year. We plan to take each ship out of service for 30 days give or take.\n\nThis is a highly efficient schedule that will be executed by our experienced team at one of our go-to shipyards. Upon completion, we will have a total of 23 vessels fitted with scrubbers. With these additions, expect it to boost earnings for the company. So, to sum it all up, we continue to stay disciplined, focusing on execution of our business model and strategy.\n\nThis includes key building blocks in delivering value for our shareholders. We are well-structured for cyclical markets with probably the strongest balance sheet among the peer group. Ample liquidity, enabling us to invest in the business and act on opportunities should they arise, all with robust downside protection without having given away the upside. The tanker market recovery has started.\n\nAnd we are tuned for this recovery through our actions and structure to create value. This includes a reduced number of outstanding shares through buybacks and an expanded and fast-track scrubber program that will boost earnings. We have substantial operating leverage in the business, combined with a significant capital distribution potential. And with that, we open up for questions.\n\nOperator?\n\nOperator\n\n[Operator instructions] We will now take the first question. And the first question comes from the line of Omar Nokta from Jefferies. Please go ahead. Your line is open.\n\nOmar Nokta -- Jefferies -- Analyst\n\nThank you. Hi, Svein. Hi, Laila. Good afternoon.\n\nYeah, I just wanted to ask, Svein, you sort of touched on the, you know, five-year contract and the durations that made it so compelling. You know, clearly, we haven't seen this much sort of time charter activity or at least that type of duration for the past, I don't know, several years or at least, I would think, a decade-plus. How would you characterize the liquidity in the charter markets today? As you mentioned, the recovery has begun. We haven't necessarily seen a resurgence in VLCC spot rates.\n\nBut how would you say the time charter market is at this point?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThe liquidity for this sort of tenor really is very, very thin. But there is quite a few clients asking for one, maybe two years, and also want a lot of options for sort of shorter durations. We don't find that very attractive. And we are very constructive on what to expect for next year in '24.\n\nObviously, beyond that, it's always hard to sort of have a specific number. Hence, we found this five-year charter to be attractive. There are some additional discussions or incoming discussions to us. So, you know, it could be that we, over time, will build more fixed income.\n\nBut hopefully, that will be at increased rates going forward, and it will also maybe be with forward delivery. So, let's see. But to your point, liquidity is thin for now, so --\n\nOmar Nokta -- Jefferies -- Analyst\n\nOK. All right. Thank you. And then, just a follow-up sort of maybe a bit more broadly on the market itself.\n\nYou know, e've seen clearly the midsized crude tankers and the product tankers lifted, as you highlighted in the release. On the VLCCs, can you give maybe a sense of just how the market here recently, maybe within the past, call it, four to six weeks, how that's been developing in terms of what you're seeing from your lens in terms of activity levels out of maybe -- out of the Middle East and then maybe the Atlantic Basin?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nSo, the market is clearly on the rise, and the rates are moving up. So, the sort of latter part of what we have booked are at higher rates than the earlier part. We are in discussions as we speak, negotiating spot voyages at the rate meaningfully higher than what we have on average booked quarter to date. And this looks to be robust.\n\nIt's not like a fast-moving super volatile, you know, change in rates, as you can see on smaller ships, but it's certainly going in the right direction. And there is a mix of inquiry from both in the Atlantic and in Asia. I think a key point here is that, you know, oil has been steeply backwardated for quite a while. And the backwardation between the fourth quarter this year and fourth quarter next year is about half in the last few weeks.\n\nAnd this will enable more Atlantic barrels to go long haul into Asia. And we see some of that already and some requests to load in the U.S. and then to discharge in Asia. And of course, this will certainly be good for our markets.\n\nOmar Nokta -- Jefferies -- Analyst\n\nOK. Thank you for that color, Svein. I'll turn it over.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThank you.\n\nOperator\n\nThank you. We will now take the next question, please standby. And the next question comes from the line of Frode Morkedal from Clarksons. Please go ahead.\n\nYour line is open.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nThank you. Hi, Svein. Regarding the final comment you made on the backwardation, actually I read the IEA report this morning, and they now actually predict global inventory build of close to a million barrels a day in the second half of this year, and a half a million barrels in the first half of next year. To me, this seems to be very positive for tankers.\n\nBut I just wanted to hear from you, how you would expect this to be impacting the tank market dynamics going forward.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nWe certainly agree with you. So, we think that the inventory cycle is the key metric in understanding the tanker cycle. And as you all know, the oil inventories have been brought down over many, many years now. You know, at some point, there has to be more feedstock, we spoke about this on our prior call and also during Marine Money conference.\n\nSo, we certainly think this is a positive. There will likely be more new ones or more supply, if you like, into the refineries, and this should certainly be good for large tankers. VLCCs are really, you know, the real workhorse of the crude market. VLCCs have on average handle about 46%, 47% of all crude being transported.\n\nAnd with Atlantic still being long oil and the big demand picture being in Asia, this is truly VLCC business from a fundamental perspective. So, although, of course, some of the smaller ships will still enjoy benefits from the disruptions, we are seeing following volatilities between Russia and Ukraine. But overall, we are very constructive on this period going forward.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nAgree. Yeah, you've been buying back shares and now announced investment in your own ship with scrubbers, which makes totally sense to me. That's great. On the scrubbers, I'm curious to know if there's been any development in the technology since you last did the retrofits.\n\nSeems to me to be a quite good price versus the obvious benefits.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nNo, it's not really in the development. The scrubbers are fairly simple. These are essentially washing machines or the model of washing machines with the capacity to handle sort of 30,000 cubic meters of water per day, a handy sized tanker, right? So -- but the cost of building them has come down. I don't think, you know, the cost for the producer, very much higher a few years back, but it was a new thing.\n\nIt was very sort of high-top, and they probably had higher profit margins on them. So, they are available to us now at one of our two key suppliers at a much lower cost than what we did last time. So, 2025, here, you will see that we budget just over 3 million per ship to do this, right, which is a significant improvement in the capex. So, our technology is basically the same.\n\nSo, there's no change.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nPerfect. Thank you. That's it.\n\nOperator\n\nThank you. We will now take the next question. And it comes from the line of Jim [Inaudible] from FactSet. Please go ahead.\n\nYour line is open. Jim [Inaudible] from FactSet, please. We will go to the next question. Please standby.\n\nAnd it comes from the line of Jon Chappell from Evercore. Please go ahead. Your line is open.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nThank you. Laila, can I start with just a couple of modeling questions for you? First of all, my apologies, I missed the spot today. I thought I caught 18,400 for the third quarter. Is that correct? And what percentage is that for?\n\nLaila Halvorsen -- Chief Financial Officer\n\nJust the spot?\n\nJon Chappell -- Evercore ISI -- Analyst\n\nYes, just the spot part.\n\nLaila Halvorsen -- Chief Financial Officer\n\nYeah. So, the -- yeah, the spot was 58% at 18,400.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nOK. Thank you. And then, Svein, you said 30 days roughly for the scrubber retrofittings, should we assume four in the fourth quarter, four in the first? And then my other question regarding to the scrubbers' new model is, how should we think about the depreciation of those? How much will it reset the depreciation higher once completed?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nSo, it's exactly which day we will enter this will depend a bit how we schedule the ships in the spot market, and we want to discharge as close to the yard as possible. So, if we can do six ships in the fourth quarter, we will do it in the fourth quarter. But -- so it's a bit hard to say this, Jon. So, sorry not being able to be more precise, but we are very confident in the fourth and the first quarter schedule.\n\nSo, you know, you will sort of be at limited to do this the way you want, but we can't give you a more precise guidance, I'm afraid. But equipment is ready, and the yard is ready. So, if we can do it sooner, we will do it sooner. But if we want to optimize the fleet to get as little off-hire and positioning cost as possible, it might be, you know, dried out.\n\nIt will not be beyond the first quarter. On the -- yeah, on the depreciation profile, we will communicate this quarter on the third quarter results. But I think it's a reasonable lead to look at what we did last time, which was a three-year depreciation profile. But it's not finalized yet, so --\n\nJon Chappell -- Evercore ISI -- Analyst\n\nOK. And then final bigger picture question. I mean, we talked about this last quarter sign on the deployment of cash as it comes in. It seems asset values have moved and at least in the situation with the VLCCs far before the rates have themselves.\n\nSo, ships was an attractive investment, maybe six to nine months ago. Just mathematically, they're probably even less so today. You've made significant headway with the buyback, and there's a ways to go there, clearly. Would you say that at this point, you remain firmly in that your stock is less than NAV and capital return is the top priority of cash? Or do you think that at a certain point, you have to start pivoting to thinking longer term and start making investments in assets even if the rates don't necessarily catch up to the asset values in the short term?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nI think, you know, when it comes to investments, we are not excited about the current trial values from a buying perspective. So, you know, it has to be a very special opportunity if we are going to buy something. When it comes to buying back our own stock, of course, NAV is also a moving element there. So, we are very happy with what we have done all sort of below $6 mark and which compares well to where the stock is trading today.\n\nBut as I think everybody knows, our capital allocation policy stayed minimum 60% of ordinary net income to be distributed. It could be that we will reduce the debt level even further. So, I think those are sort of the key metrics. But I don't think you should expect us to one, buy ships in the current valuations; and two, we will probably not buy stock at the current level side.\n\nWe will leave that to our investors and then focus on returning money to shareholders in the sort of future.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nOK. My last one is kind of a follow-up to that last point. You know, a $0.04 dividend is certainly off your minimum, so to speak, of $0.02, and in a quarter where if we take out gains, it was still a loss. So, should we think about now, as we're in the early stages of a recovery, assuming all else stays the same, is $0.04 kind of the new base dividend and then we'll transition to that minimum 60% payout once you're more sustainably in the profitability?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nNo. You know, the 60% in this quarter is actually based on the net income reported. Because compared to some of our peers, we don't exclude sort of elements in the P&L that is cash inputs, such as the sale of a ship profit. We tend to include that when we consider the dividend.\n\nSo, for us, this is just the way we've always done it. So, it's not a new law. It's just a pure reflection of what was the income for the quarter.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nOK. That makes sense. Thank you, Svein. Thanks, Laila.\n\nOperator\n\nThank you. We'll now take the next question. And the next question comes from the line of Anders Karlsen from Kepler Cheuvreux. Please go ahead.\n\nYour line is open.\n\nAnders Redigh Karlsen -- Kepler Cheuvreux -- Analyst\n\nThank you. A quick question on your fleet. I mean, you sold in 2006 and 2007 built ship. You have more or less to the same ones.\n\nWith the firming market, are you considering more sales? Or is that off the table now?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nI think for now, we will be very selective. It could, of course, be that we elect to sell one or two ships. But I think we'd like to see, in particular for the scrubber, 50 units appreciation in both asset values but also have these ships give them the opportunity to earn money, which we expect them to do. So, I don't think you should plan for our fleet to be much smaller than what it is today.\n\nAnders Redigh Karlsen -- Kepler Cheuvreux -- Analyst\n\nOK. And then just a quick one on the market. You were mentioning backwardation as one factor that is holding back. What other important drivers do you see in the short term here?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nOf course, there is supply. So, OPEC is a bit tight on handing more oil into the market. Their key argument is that they feel that they're sort of meeting current amount. And they are questioning the macroeconomic picture.\n\nI think these last couple of days, we've seen some pivots here and there, suggesting that inflation might sort of be leveling off and maybe getting some ease to some of the prior macroeconomic concerns. If that is the case, you know, maybe we'll have more oil to the market. But I think that's been the key reason holding things back is that OPEC has been tight, which we assume is they wanted to enjoy the ride of the strong prices for as long as they can.\n\nAnders Redigh Karlsen -- Kepler Cheuvreux -- Analyst\n\nOK. Thank you. And then just a final question on -- have you seen any pool from the EU in terms of building inventory -- I mean, from an energy security perspective? I guess, EU is short energy and would require to build substantial inventories of everything they can get their hands on. So, have you seen any signs of that, Svein?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nNo, I can't say I've seen that. So, of course, the gas has been more of a hot topic for Europe because oil is not really used so much for heating or for energy production, right? It's more for transportation and for petrochemicals.\n\nAnders Redigh Karlsen -- Kepler Cheuvreux -- Analyst\n\nYup.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nSo, I think there are other areas where you've seen this focus.\n\nAnders Redigh Karlsen -- Kepler Cheuvreux -- Analyst\n\nOK. Thank you. That's all for me.\n\nOperator\n\nThank you. We will now take the next question. Please stand by. Next question comes from the line of Climent Molins from Value Investor's Edge.\n\nPlease go ahead. Your line is open.\n\nCliment Molins -- Value Investor's Edge -- Analyst\n\nGood morning, and thank you for taking my questions. I wanted to ask about the disruptions you're seeing from the sanctions in Russia. The effect mostly revolve around smaller vessels, considering VLCC's heading to Russia's Western ports. But could you provide some commentary on the ship-to-ship transfers and their effect on the overall market?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nWe are not involved in those types of operations, but we are aware that they've been taking place in the Atlantic Basin. So, there's been, say, Aframax is coming out of the Baltic, and Black Sea could also potentially use Suezmax's, but this is mainly, we think, is a Baltic business. And then, we load it on to the VLCCs and then transport it to the Far East and China, in particular, being the destination. But to our knowledge, it's not a huge business tying up with many, many ships.\n\nThere's been, you know, a few of these transactions being done. So, it's a bit on the sideline of the conventional market.\n\nCliment Molins -- Value Investor's Edge -- Analyst\n\nAll right. That's helpful. And considering the high energy prices in Europe, do you expect to see any additional crude import substitution for natural gas volumes during this coming winter?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nIt could, of course, happen. So, there are some suggestions that the fuel oil will be used for heating this winter. But we haven't seen any sort of clear evidence of it or at least not to our knowledge. But I think this will be defined also by the cost differential between heating oil and gas.\n\nCliment Molins -- Value Investor's Edge -- Analyst\n\nAll right. That's all for me. Thank you very much for taking my questions.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThank you.\n\nOperator\n\n[Operator instructions] We will now take the next question. It comes from the line of Michael [Inaudible] from MRM Capital. Please go ahead. Your line is open.\n\nUnknown speaker\n\nQuestion answered. Thank you.\n\nOperator\n\nNo problem. Thank you. There are no more questions at this time. I would like to hand the conference back to the speakers for final remarks.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nWell, thank you to everyone who's been on the call and are following DHT. That's greatly appreciated, and wishing all of you a good day ahead.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nLaila Halvorsen -- Chief Financial Officer\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nOmar Nokta -- Jefferies -- Analyst\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nJon Chappell -- Evercore ISI -- Analyst\n\nAnders Redigh Karlsen -- Kepler Cheuvreux -- Analyst\n\nCliment Molins -- Value Investor's Edge -- Analyst\n\nUnknown speaker\n\nMore DHT analysis\n\nAll earnings call transcripts"}
{"id": "00ab657f-e9f7-4b62-88b9-7099bf9acff5", "companyName": "AptarGroup, inc", "companyTicker": "ATR", "quarter": 3, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2021/10/29/aptargroup-inc-atr-q3-2021-earnings-call-transcrip/", "content": "AptarGroup, inc\u00a0(ATR 0.12%)\nQ3\u00a02021 Earnings Call\nOct 29, 2021, 9:00 a.m. ET\n\nOperator\n\nLadies and gentlemen, thank you for standing by. Welcome to Aptar's 2021 Third Quarter Conference Call. [Operator Instructions] Introduced in today's conference call is Mr. Matt DellaMaria, Senior Vice President, Investor Relations and Communications. Please go ahead, sir.\n\nMatthew DellaMaria -- Senior Vice President of Investor Relations and Communications\n\nThank you. Hello, everyone, and thanks for being with us today. Joining me on today's call are Stephan Tanda, President and CEO; and Bob Kuhn, Executive Vice President and CFO. Our press release and accompanying slide deck have been posted on our website. If you are following along on our website, you can advance the slides by hovering over the presentation screen and clicking on the arrows on the right and left. As always, we will post a replay of this call on our website. Today's call includes some forward-looking statements. Please refer to our SEC filings to review factors that could cause actual results to differ materially from what we are discussing today.\n\nI would now like to turn the conference call over to Stephan.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nThanks, Matt, and good morning, everyone. I hope that you are all doing well, and thank you for joining us today. Starting on Slide 3. As you saw in our press release, we reported strong top line growth of 9% and earnings that were in line with our previous guidance. These results were made possible by our diverse product lineup and our ability to serve multiple markets within our deep portfolio of shared technologies across our segments. When taking a closer look, our elastomer components for injected medicines posted another strong quarter, and our consumer healthcare solutions resumed a positive growth trajectory. Our active material solutions continue to be in high demand, especially for diagnostics and probiotics.\n\nHowever, as we indicated previously, year-over-year sales declined in the quarter as we had a significant custom tooling sales last year that did not repeat. As a reflection of the importance of and high demand for our unique Activ-Film technology, we are honored to have been awarded a U.S. government contract that will fund a $19 million expansion for our Activ-Film domestic production. This proprietary film is used with at-home COVID-19 antigen tests. This is a validation of our proprietary technology capabilities and the important role that we are playing in the fight against the pandemic. Also in the quarter, sales of our nasal and pulmonary devices for the prescription drug market declined. The increase in COVID-19 cases during the year caused people to again stay at home, wear masks and keep socially distance. And this meant fewer common illnesses, fewer doctor visits, and consequently, lower consumption of allergic rhinitis, cough and colds and certain pulmonary treatments. In effect, this has prolonged the drawdown of inventories at our customers.\n\nThankfully, as vaccination rates continue to rise, we are seeing some positive signs that people are beginning to visit the doctors to a greater degree than before. The Delta variant, in particular, has caused some regions to again restrict social activities, and this has delayed the recovery of this part of our business. However, anecdotally, we are reading about the recent rise in the number of incidents of cold and even what is referred to in the U.K. as a super cold. So as people move up and about to a greater degree, it seems, unfortunately, common pre-pandemic illnesses are returning. Our Pharma margin in the quarter was below the prior year, mainly due to the mix of business, reflecting the lower sales to the prescription market previously mentioned.\n\nWe achieved double-digit core growth in Beauty + Home and Food + Beverage on both increased volumes and higher pricing. The beauty market continued its recovery, and we also saw increased demand for hair care and body care dispensers in the personal care market. The food market continued to benefit from at-home cooking trends, and we also saw a rebound in our beverage closure business when compared to a particularly weak period a year ago. Our Beauty + Home and Food + Beverage margins reflected the rapidly accelerating inflationary environment and related pass-through effects as well as supply chain challenges. We continue to pass on rising cost but did not fully offset those costs within the quarter. We fully expect to make up more ground in the fourth quarter.\n\nAs a reminder, the passing through of increased input cost on a dollar-for-dollar basis has the effect of compressing margin percentages. The foundational strength of our business is derived from our shared core technologies and solutions that are leveraged across all of our end markets to enable our customers' growth. I would like to highlight a few recent launches by customers using our technologies in the next few slides, starting with our Pharma segment on Slide 4. Our partner, Becton Dickinson, announced the launch of a prefillable syringe for use with biologics that incorporates our premium coast plunger with proven ETFE film-coating technology intended to ensure drug integrity. Two new FDA-approved nasally administered drugs came to market with our devices. Oyster Point Pharma's TYRVAYA is the first and only nasal spray that treats the symptoms of dry eye disease, further validating that nasal is an effective channel for a wide variety of medicines. And Hikma has launched naloxone treatment, KLOXXADO, with our Unidose Nasal Device to treat suspected opioid overdoses. Our active material technology, which protects sensitive drug products, probiotics, medical devices, food and more for moisture and other environmental conditions was recently approved with Gilead's Biktarvy, which is an oral medication for patients with HIV.\n\nIn addition, there is a new probiotic from NutraOne called probioticX, which comes in our Activ-Vial. On Slide 5, in Beauty + Home, L'Oreal's Bright Reveal skincare solutions in China features our patented airless packaging with booster cartridge for the formulation of personalized skin care solutions. In North America, our e-commerce capable solution with our twist to lock technology that prevents leakage during transportation is featured on Unilever's Baby Dove oil. And our FusionPKG business provides several patient skin care packaging solutions for Shiseido's Drunk Elephant brand. In Food + Beverage, our closure technology for flexible pouches continues to penetrate new categories and is now also dispensing Kroger's Squeezable Cream Cheese. And the brand Defy is featuring our sports closure on its electrolytes and mineral-infused water.\n\nNow turning to Slide 6. On the M&A front, we have added key capabilities in our Pharma segment. During the quarter, we closed on our agreement to acquire 80% of Weihai Hengyu Medical Products, adding elastomeric and plastic component manufacturing capabilities in China for injectable drug delivery. We also completed the acquisition of a majority stake in Voluntis, which expands our digital healthcare portfolio by adding digital therapeutic solutions and broadening our digital healthcare services across multiple chronic conditions and diseases.\n\nSubsequent to the quarter, we completed a public tender offer for the remaining shares of Voluntis and reached the required threshold to fully acquire the company. Also, in addition to our previously announced investments to expand our elastomer component capacity, we will be further increasing our capacity for our Activ-Film technology as a result of the contract awarded by the U.S. government, which I referenced earlier. This technology, in addition to protecting antigen test strips, is also leveraged across other platforms, including the protection of oral solid dose medicines, and in the food market, where we are creating antimicrobial solutions to prevent food contamination and spoilage. We expect this investment at our Auburn, Alabama site to be completed in early 2023.\n\nOn the sustainability front, 10 of our European manufacturing sites are certified with the International Sustainability and Carbon Certification, or ISCC plus -- certifications to come. This leading certification system ensures traceability, feedstock identity and can help to validate sustainability claims around recycled content and enables all of our segments to provide customers with solutions produced from certified sustainable food grade resin at a quality that is similar to that of conventional resin.\n\nWith that, I will now turn it over to Bob who will provide additional comments on our third quarter results. Bob?\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nThank you, Stephan, and good morning, everyone. Turning to Slide 7. As Stephan briefly mentioned, for the third quarter 2021, reported sales, including positive effects of currency translation rates, increased 9% and core sales increased approximately 8%, including price adjustments. Recent acquisitions completed in the quarter had an immaterial effect on the sales in the quarter. Turning to Slide 8. Third quarter adjusted earnings per share were $0.94 per share and adjusted EBITDA totaled $154 million. Adjusted earnings included the positive effects of currency translation rates and the net negative inflation impact of approximately $13 million. Our consolidated adjusted EBITDA margin would have been approximately 250 basis points higher without the net price cost effect and the margin compression impact from passing on to higher costs.\n\nSlides nine and 10 highlight our year-to-date performance, and we achieved 6% core sales growth, and our adjusted earnings per share were $2.94, up 4% compared to $2.84 a year ago, including comparable exchange rates. Briefly summarizing our third quarter segment results. Our Pharma segment's core sales declined 2%, partly due to lower custom tooling sales compared to the prior year. Adjusted EBITDA margin was approximately 32% and below the prior year's third quarter margin due to a mix of growth across the end markets. Looking at each pharma market. Core sales for the prescription market decreased 9%. As we have been discussing during the year, fewer noncritical doctor visits this season have resulted in certain pharma customers drawing down inventory levels as factors such as allergic rhinitis, cough and cold and certain pulmonary treatments are being impacted by the low levels of patient consumption. Core sales to the consumer healthcare market increased 5%, primarily due to increased revenues in the eye care category.\n\nIt was another strong quarter for components used for injectable medicines with core sales increasing 16%, primarily due to continued strong demand for our components used with vaccines. Core sales of our active material science solutions decreased 15%, entirely due to significant custom tooling revenue in the prior year that did not repeat. If we isolate that tooling revenue from the prior year, the underlying business is quite strong and would have continued with the trend of strong double-digit growth on increased demand for our diagnostic and probiotic protective applications.\n\nTurning to our Beauty + Home segment. Core sales increased 10% over the prior year third quarter. Approximately half of that growth came from increased volumes and the other half from price increases. This segment's adjusted EBITDA margin was 12% in the quarter and included the net negative inflation effect of approximately $9 million. Had we not had this price cost negative impact and we did not have the margin compression effect of passing through higher costs, EBITDA margins would have been over 300 basis points higher. Looking at each Beauty + Home market. Core sales to the beauty market increased 18%, with increased demand for our fragrance and facial skincare solutions contributing to the sales growth. Core sales to the personal care market increased 4% as higher sales to the hair care, body care and sun care markets were partially offset by declines in personal cleansing as hand sanitizer demand continues to normalize. Core sales to the home care market decreased 5% on lower demand for household cleaners.\n\nTurning to our Food + Beverage segment, which had another solid performance, core sales for the third quarter increased 28%. In addition to strong double-digit volume growth, pricing adjustments also contributed and accounted for approximately 60% of the segment's sales growth in the quarter. The segment's adjusted EBITDA margin was 16% in the quarter and included a net negative inflation effect of approximately $2 million. Had we not had this net price cost negative impact and we did not have the margin compression effect of passing through higher costs, EBITDA margins would have been over 400 basis points higher. Looking at each market, core sales to the food market increased 20% due to price adjustments and increased demand for condiment and sauce dispensing closures with consumers continuing to cook at home. Core sales to the beverage market increased 52% due to price adjustments and a partial recovery in the on-the-go beverage closure demand compared to a very weak third quarter of the prior year and a high level of custom tooling sales this year. Approximately 37% of the beverage market growth was from tooling sales.\n\nMoving to Slide 11, which summarizes our outlook for the fourth quarter, where we expect core sales growth in each business segment. Earnings growth will be tempered by business mix, foreign currency translation headwinds, inflation and supply chain disruptions. We expect our fourth quarter adjusted earnings per share, excluding any restructuring expenses, acquisition costs and changes in the unrealized fair value of equity investments, to be in the range of $0.88 to $0.96 per share. The estimated tax rate range for the fourth quarter is 28% to 30%. In closing, we continue to have a strong balance sheet with a leverage ratio of slightly less than 1.8 times, which allows us to continue to invest in the business, pursue strategic opportunities and continue to return value to shareholders in the form of dividends and repurchases.\n\nIn addition to our cash dividend payments to shareholders, which totaled $73 million in the quarter, we repurchased approximately 220,000 shares of common stock for $28.4 million. We had announced earlier this year that we had lifted the suspension on repurchases that was in place to preserve liquidity during the height of the pandemic uncertainty. We currently have approximately $250 million authorized for common share repurchases. We continue to invest in innovative growth projects across our segments, including the three accelerated projects we discussed earlier this year. Our new state-of-the-art facility being built in Suzhou, China, that will be a shared facility housing production for each of our segments, the capacity expansion in our elastomer components division of our Pharma segment to support the future supply chain for injected medicines, and the new state-of-the-art prestige beauty device site in France. We are very excited to have begun each of these projects, and we are on track with our previously forecasted range of capital expenditures for the year at a range of $300 million to $330 million. At this time, Stephan will provide a few closing comments before we move to Q&A.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nThank you, Bob. In closing, on Slide 12, we have been pleased with our ability to deliver solid results while navigating the search of the Delta variant over the summer months, various supply chain challenges and significant inflationary pressures. At the same time, we are excited about the progress we are making in positioning the company for growth beyond the current pandemic and economic environment. The completion of our recent M&A transactions and the investments we are making to support our future growth, including increasing our capacity to produce elastomer components for injected medicines and active material science solutions, represents meaningful progress on our growth strategy and ability to succeed across numerous geographic end markets and product applications.\n\nAs Bob mentioned, we expect solid core growth across each segment in the fourth quarter with considerable headwinds on earnings, including the temporary shift in Pharma's business mix. The prescription drug market demand for devices used for central nervous system treatment is expected to be below the very high level of a year ago. At the same time, we are encouraged by a partial recovery in demand for devices for allergy and asthma treatments, which are expected to be near the levels of the prior year's fourth quarter. The beauty market will continue its recovery, albeit at a more gradual pace than previously expected, mainly due to the Delta variant over the summer, delaying some projects. Our Food + Beverage segment will be up against a tough comparison to a year ago, which saw high levels of consumer stocking trends. We will continue to contain costs, improve efficiencies and raise prices to recover the effects of rising inflation. Our global procurement team is working diligently to navigate the challenging energy markets and tenuous supply chains to secure all the materials, supplies and equipment we need as we move forward. Aptar is a resilient and adaptable company. I am very proud of our global workforce and their commitment to provide the drug delivery, consumer dispensing and active material science solutions that millions of people around the world rely on every single day. With that, I would now like to open the call for your questions.\n\nOperator\n\n[Operator Instructions] Your first question comes from the line of George Staphos with Bank of America Securities.\n\nGeorge Leon Staphos -- Bank of America Securities -- Analyst\n\nHi, everyone. Good morning. Thanks for all the details. Hope you're doing well. So first question that I had for you, and I know it's very difficult to project and you gave us some helpful qualitative commentary in terms of the fourth quarter. When do you think we will be through -- when will you be through the destocking phase in pharma? Do you think, given what you know right now, given your end market channel checks, that this will be more or less resolved by the fourth quarter or first quarter? Any help there would be terrific.\n\nThe second question I had is just on guidance for the fourth quarter. Last quarter, when you were commenting, I think you said fourth quarter should be relatively close to what was the consensus at the time, which was I think a little over $1. Obviously, there are lots of headwinds that you're suffering through and everybody else's in terms of supply chain inflation and so on, and the range is where it is. Is there any way to quantify if guidance now is somewhat below where you would have expected a quarter ago? How much is in inflation? How much is in supply chain? Anything like that would be helpful. Thank you guys.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nThank you very much, George. Good morning. Let me kind of try to break it down. For the pharma picture, it's hard to give you an exact time. But clearly, we see quite some encouragement in consumer and healthcare. Unfortunately, for people, but the business scope is clearly returning. We see more and more our customers pointing to that and the order intake that we see for consumer healthcare related to cold and cough is clearly on the up. The allergic rhinitis destocking, we feel, is coming close to an end in the -- with the fourth quarter. We think the fourth quarter will be about in line with the fourth quarter from last year.\n\nWhat is, however, a drag on the fourth quarter in this prescription business is that last year, we had a huge lump of CMS orders coming through. That's kind of a lumpy business. And I cannot tell you that will that be done in the fourth quarter, will there be some spillover in the first quarter of this year-over-year effect. Now the rest of the pharma business is continuing to go from strength to strength. Our injectable business continues to grow very nicely, and we see us investing in capacity and we don't see any reduction in that. Of course, the mask on year-on-year comparisons with larger numbers will kick in. But overall, good growth in that business. And then the active material business is really -- continue to grow nicely. And we saw that nice award from the U.S. government, in fact, from the Air Force, confirming the technology we have and wanting more of that.\n\nSo overall, I think that we're kind of middle of next year, for sure, will be a normal state. Whether it's already in the first quarter, I really can't tell you. But we see the right signs. Allergic Rhinitis seems to have run its course by the end of the quarter. And overall, clearly, a rebound in pharma on the horizon. Now on your second question, I'll just give some humble pie before Bob get to the details. Clearly, we've leaned out the window a little bit more than we should have in July, and -- but we are in a very different world now. One, the Delta variant has done a huge impact on everybody, but also our businesses. Two, the inflationary pressures have really accelerated tremendously, and then the supply chain disruptions that you hear everywhere are very real. And then on top of that, you have the U.S. labor situation, which just creates enormous inefficiencies and friction losses. So I think those are the big ones that have changed our outlook and Bob can break it down a bit.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSure. So sitting back in July, when we were looking out, the two biggest drivers are going to be coming from inflation being stronger now than what we had anticipated back in July. So we were anticipating back then, and those were very, very rough numbers, about a $0.02 headwind in the -- in inflation for Q4. We're now projecting it to be closer to $0.07. So that's about $0.05 of the dots right there. And then our exchange rate assumptions back in July, we were at EUR1.19, and we're now projecting Q4 to be about EUR1.16. So you got about EUR0.02 to EUR0.03 there, depending on roundings coming from FX.\n\nAnd just to give you a rough idea, coming back to Q3, we were actually expecting -- I think on the call, I had mentioned and I've said that the net headwinds on inflation in Q3 was going to be about $7.5 million. And as you've heard from my earlier remarks, the end of about 13%. So it is truly a fluid situation, as Stephan mentioned. We didn't know about rolling electricity P&L shutdowns in Asia back in July. We weren't talking at all even thinking about energy prices spiking in Europe at the time. So these are the things that are influencing our guidance for Q4 as well.\n\nGeorge Leon Staphos -- Bank of America Securities -- Analyst\n\nOn that front, I'll join the back of the line. Thanks, guys. I'll turn it over. Very helpful.\n\nOperator\n\nYour next question is from the line of Ghansham Panjabi with Baird.\n\nGhansham Panjabi -- Baird -- Analyst\n\nYeah, thanks. Good morning, everybody. I guess sticking with Pharma for a second. So the last three years, '18, '19 and '20, double-digit growth from a volume standpoint. 2021 looks to be about flat, just sort of using your implied guidance 4Q. And I guess my question is, is that -- I understand the reasons in terms of inventory de-stock, etc, but will 2022 also be sort of a transition year before we get back to your historical growth rates? And then in terms of beauty, obviously, you're seeing some level of minor version in terms of volumes, etca, as the world has reopened in comparisons versus last year. How much of that is inventory sort of realignment, if you will, at the customer level? And should we expect a headwind at some point as we cycle through 2022?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. On Pharma, I would, first of all, say we are very much staying behind our published targets. Everything that we have in the pipeline and the everything in the market is not discouraging one bit from that. And in fact, it's encouraging us. I think very big picture Pharma's COVID impact just came a year later, and all the effects that we talked through and the lumpiness in CMS, I think, those kind of is what the other experience is -- other business experienced in 2020, Pharma is really taking an off year in '21 with -- I don't disagree with your flattish assumption. But seeing that quarter four lanes. But fundamentally, there's nothing broken in pharma. Quite the opposite. We're starting to build -- we're adding capabilities with the actions that we mentioned in the R&D investments, so fully, I do not see '22 as another off year. We can debate in the first quarter. But clearly, we see this business going back to its guided growth rates.\n\nOn beauty, I think there is some inventory effect, but the industry is clearly a lot more cautious. There was a lot of optimism going into the summer. And as Delta hit, people immediately pulled back. And now there is again a lot of optimism. So as you know, the beauty business is always about launches, in how successful is the sell-through on the launches. So I think that's the biggest question with the 11/11 go, how will Christmas go and that kind of sets us up for next year.\n\nBut clearly, after kind of a down over on the Delta, there is a lot of optimism that it was recently in Europe, at -- looks like in Monaco, and we had a lot of spark in New York last week. There's a lot of optimism in that industry also. Clearly, everybody is dealing with the same supply chain disruptions. And if I quote one of our largest customers, their operations are organized chaos. So having also to deal with their own manufacturing issues, labor availability, short shipments and all that. So the industry is gearing up for a growth year with all the additional roles that we discussed, but we're here to manage those.\n\nGhansham Panjabi -- Baird -- Analyst\n\nOkay. Thanks for that, Stephan. And just second question, maybe for Bob, on free cash flow. I mean, how should we sort of think about free cash flow for full year '21. Obviously, materially below last year. I understand there's some reasons with inventory and working capital adjustments, etc. But how should we think about the fourth quarter and just the full year relative to last year?\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. I mean I think you nailed it qualitatively, Ghansham. I mean we're going to be down off of last year and some of the reasons are obvious, right? I mean our cash spend on capital is going to be higher than it was last year. That's one thing that's influencing our free cash flow. But what we're seeing on the working capital side is as business picks up, we are seeing our receivable balances increasing. No real change compared to day sales outstanding, no collectibility issues or anything like that.\n\nOn the inventory side, obviously, the increased costs on all the laws that are coming in, and that's having an increase in the inventory valuation. And because of the supply chain disruptions that we've been talking about in certain resins and certain raw materials like colorants and things like that, we've come dangerously low in previous quarters to almost being out of stock on some of our components. So when we have the opportunity to replenish the supplies, we are doing so. So we're probably a little bit conservative on the raw material side. And then we're carrying slightly higher finished goods than we have in the past, and that's just partially due to kind of transient issues in terms of transportation and things like that.\n\nGhansham Panjabi -- Baird -- Analyst\n\nThank you so much.\n\nOperator\n\nYour next question is from the line of Mark Wilde with BMO Capital Markets.\n\nMark Wilde -- BMO Capital Markets -- Analyst\n\nGood morning, Stephan. Good morning, Matt, Bob. So Bob, I wondered if you could just help us with any way of quantifying drag in the third quarter from the labor issues that you mentioned, but also any issues with global logistics. I'm conscious that historically, you've shipped component pieces from one part of the world to another.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSo I can't really give you hard numbers on the breakout between supply chain and labor. I will tell you that of the total net negative inflation, about 80% of it is coming from materials, and then 20% is really making up the rest. Our labor issues are primarily North America, that's more of a North American issue. The transportation and the supply chain is more of a global issue. We're doing OK on our intercompany component shipments and things like that. It's more -- in many cases, lack of truck drivers to be able to ship finished goods to customers, etc. So we're doing what we can to make sure that in some cases, we're producing in advance of shipment dates to make sure that the customers are getting the products on time. But I can't really break out specifically how much is labor. That's more of a U.S. issue.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nMaybe let me add some qualitative comments here because it is really pervasive. So in the end, what happens is we are understaffed at several of our large facilities to the tune of often having 10% to 15% of the headcount not staffed. That results in you can't run certain shifts. You can't ship some products. Obviously, we have various wages across all of the factories. And then often, we have to pay sign-up bonuses, retention bonuses. And often people just wait for the first day after we got the retention bonus and they've punched out. So it is a very unprecedented environment. It's not only us facing that. It's our customers facing that. Europe is by far better. But also, in Germany, it's pretty tough to hire qualified people. So -- but by far in the U.S., it's the biggest impact. And as Bob said, truck drivers are very high demand. And our customers just can't pick up the shipment. So the U.S. environment is pretty hard now. Over time, we will certainly look more to automation than before. It's just the logical consequence because the labor market is not going to ease up anytime soon.\n\nMark Wilde -- BMO Capital Markets -- Analyst\n\nAnd Stephan, did you also lose or defer any sales in the third quarter? Because of just inability to produce enough or to deliver or not?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. I mean look, it's a whole portfolio. Clearly, we have some lines that are flat out where we -- if you could sell more -- if you could make more, we could sell more. There are other lines that is not applicable, everybody is tight. And then sometimes, we work very hard to get things done and then the customer didn't pick it up because their schedule changed because they don't have the labor. So in general, it's more fraction. Mathematically, could be absorbed more, yes, I think so. But will that automatically be a percentage or two for the fourth quarter, I'm not so sure.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. I would add, Mark, that when we started to see these transportation disruption, that was earlier in the year. So earlier in the year, we did have some shipments that were ready to go that didn't go. But I think now, what you got is what was supposed to go in Q2 ended up now going into Q3. And maybe we've got some sitting that should have gone on Q3, it's going to go to Q4. We're going to have things in Q4 that's going to roll in Q1. So I don't think quarter-on-quarter it's a significant effect. And certainly, I wouldn't sit here and say that where we're sitting on massive shipments that will fall into Q1.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nThat's right. The main thing -- highly kinetic dynamic environment, and you changed on the time and in the end, you end up with more cost. And then...\n\nMark Wilde -- BMO Capital Markets -- Analyst\n\nOkay. I'll turn it over, Stephan. Thank you.\n\nOperator\n\nThe next question is from the line of Kyle White with Deutsche Bank.\n\nKyle White -- Deutsche Bank -- Analyst\n\nHey, good morning. Thanks for taking my question. I wanted to focus on pharma. I think we all recognize the inflationary environment, supply chain issues with regards to packaging and you gave the inflation impact in your other segments. But pharma is a bit more unique. Can you just talk about how your price cost has been in that segment? What level of inflation are you seeing outside of materials? And are you able to price to cover? Or is there a headwind and still contractual resets there? Thank you.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSo on the pharma side, the net negative for the entire segment was around $2 million. So roughly about 100 basis points on the margin. I would say the majority of that is probably from our active material science division than it is from the others. Again, I can't really break down what the -- I can't parse out what's coming from labor or anything.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. I mean we are also repricing in pharma, but that is more on an annual basis. And where you can break into contracts, we do that. But this is much more long-term industry and it's not something that you do month-to-month.\n\nKyle White -- Deutsche Bank -- Analyst\n\nGot it. And then on Beauty, it seems like consumers are looking to do holiday shopping sooner. Are you seeing this or gaining some customers? And what kind of impact did this have on you? How do you manage that in terms of lead times with your customers given the tight supply chain?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. I mean, lead times are obviously a lot longer. So I'm not sure I can give you more color than that. We saw people taking the foot off the gas as delta hits. And now they're stepping on the gas again. Obviously, a lot of regional differences. China, with 11/11 is scrolling that up and then scrolling up for the Chinese New Year. U.S. Christmas season will tell us a lot. Europe is actually going very well as vaccination rates have moved ahead of this country. I must say, moving around is much easier and the shops are open, so the recovery in Europe is actually going well. So overall, we are very positive on the pickup.\n\nKyle White -- Deutsche Bank -- Analyst\n\nThanks. I'll turn it over.\n\nOperator\n\nNext question is from the line of Gabe Hajde with Wells Fargo.\n\nGabe Hajde -- Wells Fargo -- Analyst\n\nGood morning, Stephan, Bob, I wanted to, I guess, clarify what I heard for Beauty + Home that the lag in recovery was about 300 basis points in the EBITDA margin. So it puts us close to kind of that 15% range. So if you could confirm that. And then more importantly, it looked like restructuring had kind of jumped up again this quarter. And I don't know if that's a timing issue or if there are some other things that you guys are trying to accomplish to kind of restore the margin profile there and get to that $80 million of transformation savings that you talked about before.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSure. So yes, I can confirm the 300 basis point impact in the Beauty + Home in net negative, which was in terms of absolute dollars about $9 million. As far as the larger-than-expected restructuring costs, we had talked about even last year shutting down some of our East Coast operations and merging them into existing North American facilities. We had to delay that, as you remember, last year because of the demand for sanitizers and pumps, which were being produced at the time in our East Coast facility. So that large -- majority of that large restructuring costs is coming from the finalization of that plan, and now we moved everything into the other North American facilities.\n\nGabe Hajde -- Wells Fargo -- Analyst\n\nOkay. Could you maybe quantify for us what the fixed cost savings might be with just that action right there or...\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nI don't know. I'd have to check and get back to you around that as of [Indecipherable]...\n\nGabe Hajde -- Wells Fargo -- Analyst\n\nAll right. Thanks, Bob. The other one I was curious just thinking about kind of capital redeployment. You guys bought back about 28 million in shares versus this quarter. How active kind of the M&A environment is? And kind of how you guys kind of go through the decision tree, share repo versus making an acquisition? And sort of in the context of ROIC targets that you guys put out there with Capital Markets Day and then appreciating that it's also part of your kind of incentive comp.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. I mean, in general, the M&A environment continues to be very active, and we continue to be very disciplined. So there's a lot of deals that we look at, and in the end, decide to step away or simply do not pay the prices the seller expects. But if we step back on our overall capital allocation, clearly, our first priority is to invest in the business with capital expenditure projects and a return on those are the most predictable and throughout the returns on our capital expenditure projects have been very steady and north of 20%. So that is the first priority. Then, of course, we have, I think, 28 years of annually rising dividend and we're about to break that streak. And then comes M&A and share buybacks. Clearly, we've paused the share buybacks at the height of the pandemic to be more cautious and preserve liquidity. But now we are back in the market as we've seen it before, and certainly, I have no reason not to continue that.\n\nGabe Hajde -- Wells Fargo -- Analyst\n\nThanks for the [Indecipherable], Stephan. Good luck.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nThank you.\n\nOperator\n\nYour next question is from the line of Adam Josephson with KeyBanc.\n\nAdam Josephson -- KeyBanc -- Analyst\n\nStephan, Bob, Matt. Good morning. I hope you're well. Bob or Stephan, just on that -- the restructuring issue that Gabe was just asking about, is it fair to assume then that we should not expect to see much of the way of restructuring charges in future quarters? And just relatedly, how would you frame the returns that you think you've realized on all of your restructuring actions over the past, say, three or four years?\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSo I'll take the first part of the question. Yes, the -- I think it's safe to say that we're at the tail end of the official kind of restructuring charges and whatnot. So I think that's a true statement. As far as the actual returns, I mean, it's a multiyear project. But I think what you're seeing is that we continue to rightsize the business, improve the capability, the front end of the business during some very difficult times. And so we've taken about eight plants off-line and in our business, we've gotten more efficient investments in capital. So I think really if you take a step back, we've done what we said we were going to do and the transformation. And I think we're very well situated for the rebound to come. So visible right now with COVID and everything there to say, \"Hey, we got a great return out of this.\" Talk to me in a couple of years when the business normalizes and I think we'll have a different discussion.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. I would just add, I know it's been a while, but if I compare our position in the market, our feedback from customers, both qualitative and quantitative, I would compare a business that's on the back foot losing share to our business that's on the front foot that's gaining share. And it's also tailored it geographically to the high-growth areas. So for me, that's a pretty important consequence of all efforts that work. Now we're never done. So but certainly agree with Bob on the restructuring charges, I think that for the most part, that's it.\n\nAdam Josephson -- KeyBanc -- Analyst\n\nI appreciate it, Stephan and Bob. And just, Bob, you made a comment that when business conditions normalize in a couple of years, we'll see the fruits of this labor. And to that point, there have been so many unanticipated problems from the pharma destocking, to the Delta variant, inflation, supply chain issues, etc. How do you foresee this preliminary stage, I mean, how do you foresee next year shaping up? Do you expect many of these same problems to persist? The other pharma destocking aside, for the most part, do you expect any of these problems to persist? Or do you think it will be a clean year next year? Just any thoughts about how next year might evolve compared to this year, just given how unexpected so much of what's happened this year has been for you?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. Maybe let me can assume that for a moment, and then, Bob, please add. Look, how do you forecast Black Swan events? Nobody is predicted toward it nor all the variants that came. I'm actually very proud of the team, how the team has managed through the COVID. And Delta probably, hopefully, was the last of that story. And I wouldn't character it as problems. I would characterize it as issues that the team stood up and dealt with, including the current and -- that is one of the strengths of Aptar. And when you look at the resiliency, last year, we were flat. This year, we're growing again. And the dealings, of course, with the after effect of pharma, but that's also related to COVID. So I think the company is handling those issues very well. Now if you can tell me that none of these issues will be there next year, we'll have again rest of the year. So -- but if there is another Delta variant, we will have to deal with it. We will be dealing with it. We have a capable team. I think I gave good color on our expectations on pharma and beauty. So now if you tell me there will be no echo and whatever variant, and I think we'll have a good -- great year.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. I mean I would just add, Adam, I mean, how do we look at it? It's a challenge, right? But as Stephan said, I mean I go back to 2008, 2009, in that crisis. And the only way you can deal with it is through on-the-shelf contingency planning, and that's something that we did in '08 and '09. We continue to do today. So do we have the budget and the forecast for next year. Of course, we do it based on a number of assumptions. But we also have various contingency plans in place that we're ready and willing to execute should, as Stephan said, another Black Swan event happen, right? And on the flip side, we also have the balance sheet and the wherewithal to invest where we need to invest if things go better than we expected as well. So I mean I think that's the only way you can manage through this. It's difficult to predict, but I think having the flexibility in the muscle and the contingency plans in place and the experience that we've had really is what makes us kind of weather through these storms.\n\nAdam Josephson -- KeyBanc -- Analyst\n\nThanks a lot, Bob.\n\nOperator\n\nYour next question is from the line of Angel Castillo with Morgan Stanley.\n\nAngel Castillo -- Morgan Stanley -- Analyst\n\nGood morning, and thanks for taking my question. Just try to deliver to the point on pharma, which is maybe a different way of looking at it. As you think about kind of destocking here that, that continues into the fourth quarter, would you say -- would you characterize, I guess, customer levels of inventory as getting closer to normal? Or are they looking to run leaner than they had historically?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. So again, I would break this down -- remember, we have four units in Pharma, three of which are growing nicely. And the active materials and injected was at double digit. The -- and within the prescription division, we had significant destocking in allergic rhinitis and cold and cough. Cold and cough is behind us. We clearly see that business on the uptake. Allergic rhinitis seems to be normalizing as we said that we think quarter 4, '21 levels will be in line with quarter 4, '20 levels, which were unaffected from the destocking. So the one additional item that we're calling out in our prepared remarks is that we had a very big lump of CNS sales last year that will not most likely repeat. And that's why we see prescriptions still being not in a growing mode compared to the rest of the pharma businesses.\n\nAngel Castillo -- Morgan Stanley -- Analyst\n\nYes. And then I guess that's my one. Thank you. I guess just to clarify, the way I'm kind of thinking about it is, if we kind of get more to a normal environment, are you -- do your customers have enough inventory? Or do they have to kind of -- particularly within prescription, I mean, as you think about kind of easier comps in the next couple of quarters and the destocking that has happened, is there the opportunity for maybe a little bit of restocking or kind of a little bit of improvement there?\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. I would not want to speculate. The one thing I also would call out, we've done really a deep dive into kind of what's sold in pharmacies in the retail environment. But please also remember that the CNS distribution channels are very completely unconventional. I go through emergency response crews and schools and there is no data.\n\nAngel Castillo -- Morgan Stanley -- Analyst\n\nUnderstood. Thank you. That's very helpful. And then just a separate one on -- you mentioned automation investments as a potential, I guess, to answer to some of the labor issues that we continue to have in the U.S. So is that contemplated in the restructuring that you've done? Or one, I guess, maybe what would that mean as we look forward to 2022, and we continue to have these -- the persistent kind of tight labor issues? What would be kind of the thought process around that? How much would you need to kind of invest in the business to kind of automate further? Or as we think about kind of restructuring on that?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nNo, I wouldn't call it restructuring. I think this is just normal productivity investments. When you look at the economic return of every investment, what is the headcount savings you're going to be able to create with the investment we do when we do the business case.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. I mean I think in our restructuring and transformation, we talked about a little over $50 million that we invested specifically in the automation and automating the factories. That ranges from anything for material handling to final packaging and shipping and things like that. And as technology improves and increases, we'll continue to look for ways to automate and be more efficient. I mean that's part of our kind of annual G&A.\n\nAngel Castillo -- Morgan Stanley -- Analyst\n\nVery helpful. Thank you.\n\nOperator\n\nYour next question is from the line of Daniel Rizzo with Jefferies.\n\nDaniel Rizzo -- Jefferies -- Analyst\n\nThank you for filling me in, guys. You mentioned the tooling comparison being pretty tough in Q3. I was wondering if it's going to be, again, tough in Q4 or over the next couple of quarters?\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSo Daniel, I mean, the tooling for us is, if you actually were to look at it overall, we were actually up slightly in total companywide tooling. It always impacts one or more markets. So pharma happened to be a negative drag on pharma this time. But remember, we've mentioned that beverage was accounting for about 37% of their growth. So it was a positive there. Right now -- and again, tooling is one of those things that's difficult to forecast. You're not exactly sure when production tooling is going to come online. But right now, we're not expecting on a consolidated level any significant differences with the prior year.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nAnd maybe, the specific one in active material solutions, Bob, you can -- we already preannounced so to speak, that, that was coming.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. Yes. So last year, we were up 50-some percent in active material solutions in the third quarter, and that was due to really an exceptional tooling sale on the success of pharma customers flash glucose monitoring systems. So this was kind of the next evolution of their product range that obviously is a positive for us going forward. But those types of fueling events don't happen every quarter, and certainly, don't always happen every year either.\n\nDaniel Rizzo -- Jefferies -- Analyst\n\nOkay. Thank you for the clarification. And then labor and supply chain cost aside, if you look just at your raw materials, particularly like polyethylene, polypropylene and things like that. I was wondering what your expectations are going forward? I mean, with respect to your guidance, are you expecting it to continue to rise and playing catch-up or just kind of a plateau here or what?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nSo it's expected as of now to decrease slightly in North America and in Europe, but it will still be at much higher rates than what we saw last year. So yes, it's not increasing at the rate we've seen over the last several quarters. We're expecting to kind of abate and potentially subside a little bit, but it will still -- year-on-year comparison is going to be significantly higher than the prior year.\n\nDaniel Rizzo -- Jefferies -- Analyst\n\nThank you very much.\n\nOperator\n\nYour next question is from the line of Salvator Tiano with Seaport Research.\n\nSalvator Tiano -- Seaport Research -- Analyst\n\nYeah. [Indecipherable] Thanks for taking my questions. So firstly, [Indecipherable] going back to pharma and tooling. It seems to me like the mix of your business didn't become much worse in the third quarter from what we saw in the first half of the year. If the earnings decline accelerated a lot, I wonder if you can provide a little bit more details on why this happened? And if you can put a finer print on the decline in the active solutions tooling sales and what was kind of the year-on-year impact on profitability?\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nOkay. So the mix is what we've been talking about really, Salvator, on the previous quarters. I mean that relates to the destocking factor around the allergic rhinitis products and as most COPD-type products. And that's primarily in our Rx division. And we did a destocking in Consumer Healthcare earlier in the year around [Indecipherable] decongesting cough and cold. We now are starting to see that improve. As Stephan has mentioned, cold and flu season is back. Device sales are increasing on short term horizon. We talked about the recovery in allergic rhinitis and asthma, COPD and a little bit of a tough comparison compared to CNS in Q4. As for active materials, I can't comment specifically. We don't make a lot of money on tooling sales, in general, but it was about $12.5 million in total tooling revenue for active material solutions last year in the third quarter. So again, as I mentioned, that's a positive from us from the standpoint that that's going to lead to future product sales, which is really what we're focused on with our customers.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nSo Salvator, let me just assume out to be hopefully outlook. So again, as a reminder, our Pharma reporting segment consists of four business units. And they have different profitability. Although we don't disclose it, but we give directional guidance. The most profitable one is prescription drug, and the big units there are allergic rhinitis and the COPD pulmonary treatment, with a nice growth engine being the central nervous system drug business. That's in prescription. Then comes consumer healthcare. Slightly less profitable, everything around cough and cold, nasal rinse, thermal treatment, ophthalmology. Then comes active material solutions in terms of profitability. And then comes the injectable business, which is still nicely profitable in the context of the overall company. And of course, when injectable and active material grows a lot faster and prescription declines, you have a mix effect, and that's really what has played out this year.\n\nSalvator Tiano -- Seaport Research -- Analyst\n\nOkay. Understood. And the other question, if you can provide a bit more detail on the financial impact of the two recent acquisitions. Especially, I think Voluntis, given that problem statement they do have an operating loss, if I remember correctly. So how should we think about the impact on your earnings from this?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. Bob can give some numbers. But in general, Voluntis is basically a R&D investment into the digital therapies and digital companions to all of our devices in the long run. So this is really an investment in the next-generation platform. We have Voluntis, as you know, it has been a public company, still is. Thankfully, we've crossed the threshold and we'll be able to squeeze minorities out, but this is adding to our digital therapy capability. You can find in their public filings, the revenues used to add. But for us, we think of this as a significant R&D effort but still be afraid by rising business. Then if I pivot over to Weihai Hengyu, that is very important getting boots on the ground in China for the injectable medicine segment. Significant growth from that part of the world. So far, we serve that mainly with -- exclusively with imports from Europe on injectable medicine, and this is a long term not sustainable. And this is a nicely profitable business that will allow us to expand in that part of the world, building on the basis of Weihai Hengyu. In general, our overall M&A track record, I think, is very good. We talked about that at Capital Markets Day. Of course, CSP, which became the active material science business as well as FusionPKG, the two larger ones doing very well, but also our venture investments are returning very nicely. So maybe, Bob, you can give some numeric impact.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nSure. Sure. So in Q4, the Hengyu and the Voluntis acquisition will probably be $0.02 to $0.03 dilutive and that's pretty typical as you kind of got to work through some of the inventory write-ups and the like on the purchase accounting side. And then looking at it in 2022, it's going to be roughly $0.08 dilutive, primarily coming from the digital health investment. And I can't really give you a break out what that is, but improving as we move beyond 2022.\n\nSalvator Tiano -- Seaport Research -- Analyst\n\nOkay, [Indecipherable]. Thank you very much.\n\nOperator\n\nYour next question is from the line of Justin Lane with William Blair.\n\nJustin Lane -- William Blair -- Analyst\n\nHey, good morning. Thank you for squeezing me in. Just two quick ones for me. I guess, what's your expectation for the upcoming cold and flu season, that's baked into your guidance? You mentioned there's potential super cold in Europe. So I guess, does that mean you're expecting something similar to pre-pandemic norms or maybe still something lower?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. I think the last couple of days, several of our pharma customers have had their earnings announcement. So I think reading their statement is probably as good an answer as I can give you. Clearly, whether it's the CDC, our customers or anecdotal evidence from our colleagues in Europe, it looks like it's going to be a -- called normal flu season, maybe even above normal. I don't want to speculate. And we clearly are going with optimism into the fourth quarter in our Consumer Healthcare business.\n\nJustin Lane -- William Blair -- Analyst\n\nOkay. And just another one for me. You talked about raising your prices and continuing to pass the cost down to your customers. But I guess I'm curious, what other measures do you have in place to navigate of this environment if inflation and particularly supply chain and labor shortage just continue for another year?\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nThree words, pricing, pricing, pricing. I mean we are very vigilant in raising prices, ensuring that we pass on this higher cost. Yes, it is with a delay often and we're getting better at that. I want to recognize our food and beverage business is really structurally change how they do that. So to this time but general inflationary increases, we passed them on. And to be honest, while every price increase is tough, the environment is a lot more receptive because our customers just have it everywhere. So nobody is surprised when we walk in there and say, hey, guess what, we got to do another one.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. And I would just add, right now, I mean, you see a lot of reports out that consumers are accepting our customers pass through of higher cost. But I mean, if you look at us historically, we don't just serve the multinationals. We also serve a lot of the private label brands. And so that's something that we'll be keeping an eye out on. You could see a shift in business from branded products, if prices get to the point that consumers want to save with a few pennies. But typically, for us, that doesn't mean any less sophistication around dispensing, ease of use. And we're selling to the private labels roughly what we're selling to the multinationals.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nAnd I mean, of course, I'm not inclined that we're not doing all the other work that you would expect us to do around productivity savings, automation and so on. But the marketplace is at work. And we use all the tools that are available in the marketplace to attract and retain the right labor. It's just got a lot harder than it's been for a while.\n\nJustin Lane -- William Blair -- Analyst\n\nThat's great. Thank you so much.\n\nOperator\n\nWe have a follow-up question from the line of George Staphos with Bank of America.\n\nKashan Tula -- Bank of America -- Analyst\n\nHi everyone. This is Kashan Tula on behalf of George Staphos here. I was just wondering quickly if you could go through the charge related to PureCycle and just remind us on the background of the partnership there.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nYes. So PureCycle was an investment that we made a year ago or so that went public via SPAC vehicle in the second quarter. So we saw initially in the quarter as they went public. We had a huge gain of about, I think, $16 million, $17 million and the unrealized write-up of that investment. And now it was about a $9 million write-down. But net-net for the year, on an unrealized basis, we're still up about $6 million.\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nYes. And just as a reminder, a large part of our polymer use is polypropylene. And as our customers need to have more and more recycled content, what we need to have in the world is recycled polypropylene that is food grade. So they can be in contact with food, with medicines, with beauty treatments. And PureCycle is one of the few that developed the technology. So this is one of the measuring investments that was really strategic for us to help them get off the ground, make sure that this technology sees the light of day. And thankfully, other people have seen the same potential, including some of our customers and investors in that. Now they still have to build large-scale plans, but clearly, the marketplace -- the capital market is seeing the same potential. So it's just one example of the kind of interim investments we do in early stage to make sure that we are at the leading edge of innovation without putting all our money into those things. But it's a good example that the technology that we need to be available in the marketplace.\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nAll right. With that, we're going to wrap it up. Appreciate all the questions. Again, we look with confidence into quarter four as these trends work themselves out, and we look forward to talking to you on the road.\n\nOperator\n\n[Operator Closing Remarks]\n\nDuration: 67 minutes\n\nMatthew DellaMaria -- Senior Vice President of Investor Relations and Communications\n\nStephan B. Tanda -- President, Chief Executive Officer and Non-Independent Director\n\nRobert W. Kuhn -- Executive Vice President and Chief Financial Officer\n\nGeorge Leon Staphos -- Bank of America Securities -- Analyst\n\nGhansham Panjabi -- Baird -- Analyst\n\nMark Wilde -- BMO Capital Markets -- Analyst\n\nKyle White -- Deutsche Bank -- Analyst\n\nGabe Hajde -- Wells Fargo -- Analyst\n\nAdam Josephson -- KeyBanc -- Analyst\n\nAngel Castillo -- Morgan Stanley -- Analyst\n\nDaniel Rizzo -- Jefferies -- Analyst\n\nSalvator Tiano -- Seaport Research -- Analyst\n\nJustin Lane -- William Blair -- Analyst\n\nKashan Tula -- Bank of America -- Analyst\n\nMore ATR analysis\n\nAll earnings call transcripts\n\n"}
{"id": "00b0e6f9-59e4-447d-a9fd-c94a17c15733", "companyName": "Energy Vault Holdings, Inc.", "companyTicker": "NRGV", "quarter": 2, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/08/energy-vault-holdings-inc-nrgv-q2-2022-earnings-ca/", "content": "Energy Vault Holdings, Inc.\u00a0(NRGV -0.37%)\nQ2\u00a02022 Earnings Call\nAug 08, 2022, 8:00 a.m. ET\n\nOperator\n\nLadies, and gentlemen, good morning, and welcome to the Energy Vault Q2 FY 22 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] As a reminder, this conference is being recorded.\n\nI will now turn the call over to Mr. Laurence Alexander, chief marketing officer. Please go ahead.\n\nLaurence Alexander -- Chief Marketing Officer\n\nThank you and good morning, and welcome to Energy Vault's second-quarter 2022 earnings conference call. As a reminder, Energy Vault's earnings release and a replay of this call will be available later today on the Investor Relations page of our website. This call is now being recorded. If you object in any way, please disconnect now.\n\nPlease note that Energy Vault earnings release in this call contains forward-looking statements that are subject to risks and uncertainties. These forward-looking statements are only predictions and may differ materially from the actual future events or results due to a variety of factors. We caution everyone to be guided in the analysis of Energy Vault by referring to our 10-Q filing for a list of factors that could cause our results to differ from those anticipated in any forward-looking statement. We undertake no obligation to publicly update or revise any forward-looking statements, except as required by law.\n\nIn addition, please note that we'll be presenting and discussing certain non-GAAP information. Please refer to the Safe Harbor disclaimer, and non-GAAP financial measures presented in our earnings release for more details, including a reconciliation to comparable GAAP measures. Joining me today on the call is Robert Piconi, our chairman and chief executive officer; and David Hitchcock, our interim chief financial officer. At this time, I'd like to turn the call over to Robert Piconi.\n\nRobert Piconi -- Chief Executive Officer\n\nGreat. Thank you, Laurence,\u00a0and welcome everyone to our second quarter 2022 financial results conference call. I want to start my remarks today with an overview of the key highlights from the quarter, including the recently announced project awards you may come across this morning in our release representing approximately 1 GWh of new projects. David Hitchcock, our interim chief financial officer, will then walk you through the financial results in more detail before we open the line for questions.\n\nWe made strong progress with what we achieved through the second quarter, as we continue to execute on our 2022 regional priority for deployments as we originally planned in the U.S., Australia, and China. That provide us tremendous momentum going into the second half of 2022 while setting ourselves up well for 2023. Let me start in Australia. We're building on our announced strategic partnership with Korea's Zinc group.\n\nWe announced the commencement of site and feasibility planning with Ark Energy. The Australian wholly owned subsidiary of Korea Zinc for multi GWh of both long and short duration storage projects, supporting its sister company, Sun Metals Corp in north Queensland, Australia given their stated commitment to being powered 80% by renewable energy by 2030. In November 2020, Sun Metals joined the RE100 and plans to become one of the first refineries in the world to produce green zinc. More recently, in May 2022, Ark Energy announced a friendly acquisition of Epuron Holdings in Australia, and now has a portfolio of approximately 9GWh of future wind and solar projects to support its strategy to become one of the largest producers of green hydrogen in Australia.\n\nOver to China, we previously announced the groundbreaking of Atlas Renewables 25 megawatt, 100 MWh gravity-based storage solution, and construction continues to proceed as planned. All permitting, side activities, and initial civil works have progressed well through the summer, after some initial delays coming out of the COVID-related shutdown in Shanghai. With all 1200 foundation filings completing this month, the focus now shifts to the foundation, the fixed frame buildup, and the power electronics, which are all under-way in parallel with the composite brick production locally. We expect mechanical completion and the beginning of system commissioning in the fourth quarter this year.\n\nEnergy Vault will directly support on-site the 100 MWh project in Q4, and into next year with the power electronics start-up, overall system, mechanical completion, and final system in software commissioning the full operation. I want to provide a bit more color on the local development activities in China as well. Atlas Jiangsu, in collaboration with the Energy Investment Professional Committee of Investment Association in China or referred to as EIPC, has also engaged with China's top five state-owned enterprises power utilities, and energy companies in discussions to support their decarbonization processes, by providing energy evolved resiliency centers based upon our EVS platform. Additionally, multiple 100 MWh projects are under development across China, as well as larger GWh gravity storage projects in other provinces under the Zero Carbon Park Initiative, also sponsored by EIPC.\n\nIn collaboration with the EIPC and with additional support from the National Center for Sustainable Development, and the Bush Global Advisors Group. Atlas Renewable will partner with EIPC five Regional Zero Carbon Park Program across China. A key objective of this will focus on the value of the EVx technology storage solution to support local grid and regional industrial renewable power needs. Atlas Renewable is supporting the efforts by EIPC to demonstrate energy evolved gravity energy storage technology for inclusion in the New China Energy Green Standard.\n\nTo better ensure direct local support and more financial flexibility, Energy Vault is establishing a wholly owned foreign subsidiary in China, which is expected to be operational in October 22 to support Atlas China Tianying and the China market more broadly. Shifting to the U.S. market, we received a limited notice to proceed with Enel Green Power in May 2022, which continues to be on track with the upcoming deployment of the first U.S. based gravity system in Snyder, Texas, which is expected to break ground in the next 60 days.\n\nIn May. We also announced with DG fuels the doubling of size and increased scope of our previously announced project, and providing the production of green hydrogen to support the biomass waste to energy process in the manufacturing of sustainable aviation fuel. Under the terms of the original agreement, Energy Vault agreed to provide 500 MWh for the first three projects starting in Louisiana. This specific project was increased in capacity and now developed to support up to 73 megawatts for 16 hours, reflecting a total of 1.168 GWh and storage capacity for this first project.\n\nDG Fuels plans to follow the Louisiana Project with additional projects in British, Columbia, and Ohio, with an opportunity for total storage capacity of 2.234 GWh overall, and up approximately 735 million in project revenue over time, as previously announced in the quarter. In April, we announced the signing of a Memorandum of Understanding or MOU, for gravity-based energy storage technology and our energy management service platform with NTPC, India's largest power generating utility to support their clean energy transition. The MOU is to collaborate and formalize a long-term strategic partnership for the deployment of energy bolt EVx gravity-based energy storage technology, and its energy management software solutions based on the outcome of a joint feasibility study which is underway now. This is a tremendous landmark day for Energy Vault, and the execution of our software and Energy Vault solution strategy announced just nine months ago with the addition of John Jung and\u00a0Akshay Ladwa to the Energy Vault team in November 2021.\n\nToday we are making multiple project award announcements totaling nearly 1GWh, progressing our first Energy Vault solutions project integrating battery energy storage systems. Our technology agnostic energy management software platform extends our offering to enable both short and long-term duration storage solutions with diverse underlying storage technologies. EBS now enables our customers to utilize the same software platform across their energy generation and storage platforms, while future-proofing their evolution to longer duration storage as renewable energy continues to grow as a percentage of the power generation mix. We are announcing three project awards today, a 275 MGH project with Wellhead electric and W Power in Southern California.\n\nA 220 MWh project to provide energy and ancillary services to the ERCOT market in Texas, and resource adequacy to the capital market in California with a leading independent power producer. And finally, a 440 MWh project with the large Western U.S. public utility. All of these awards will be followed shortly with customer announcements.\n\nThe project with Wellhead electric is a 275 MWh energy storage project in Orange County, Southern California. Through our EVS team, we will deploy a 68.8 megawatt battery energy storage system at Wellhead energy reliability center in Stanton, California, to provide enhanced resources and improved grid reliability to the Southern California Edison Territory. The Stanton energy storage system will be one of the largest energy storage systems in Southern California. All of these projects were based on our EVS proprietary system design and energy management software for optimal economic dispatching.\n\nThese contracts reflect successful execution of our EVS technology agnostic strategy, to provide customers with the most flexible and cost-effective energy storage solutions. I want to call it a special thanks to Akshay Ladwa, our chief engineer at EVS, and his team for their innovation and agility, and speed in the development of the new platform, coupled with an intense customer focus to support the project awards announced today. As well as Marco Terruzzin, and his commercial team in winning the trust of the newly announced customers through a relentless focus and a passion to serve their needs while solving complex problems. With a new market introduction of our EVS platform and services, coupled with the ongoing multi-continent deployments of our gravity storage solutions, we are well-positioned to take advantage of what remains a very healthy and growing market.\n\nFrom an industry perspective, demand trends remain robust for storage technology across durations, supported by carbon neutral and reduction targets from corporations and some of the largest countries across the globe. If you look at the second half of 2022 and full year guidance, we are expecting revenue in the range of $75 to $100 million reflecting gravity project starts as well as newly awarded EVS project starts in Q4 this year. We currently expect adjusted EBITDA in the range of -$10 million to +$3 million for the year. As we look at 2023 and the gravity and the every project awarded and underway, as well as the early development activity in China referenced earlier, we are expecting the aggregate revenue for 2022 and 2023 in line with our original investment plan, for a total of approximately $680 million across both years.\n\nWe continue to see many positive regulatory macro trends that will benefit and evolve business trajectory. We are excited about the announcement this past weekend of the approval in the Senate of the Inflation Reduction Act, and believe that the inclusion of the stand-alone storage, ITC and support for clean energy initiatives will continue to greatly benefit our growth strategy and that of our customers. Our gravity and battery storage solutions are seeing heightened demand due to this economic value we are able to create without ITC or tax subsidies, but this legislation will serve to support and accelerate our growth trajectory. Additionally, we continue to make good progress in the build-out of our global supply chain and other infrastructure capabilities, as we execute on our initial projects, and continue working to source, and qualify critical materials, and establish key supplier relationships globally.\n\nFor our EVx gravity solution, over 50% and up to 75% of our solution is sourced locally within the region, eliminating some of the challenges facing many other storage providers in the industry, while maximizing the application of the regulatory incentives for local content and job creation. I also want to highlight a key action that the board implemented an extended lock up agreement for 100% of the executive officers, who held equity awards invested on an accelerated basis upon the closing of Energy Vault business combination and IPO in February 2022, impacting equity awards underlying a number of the shares that equal to approximately 5% of the shares outstanding as of June 30, 2022. This underscores our alignment with our shareholders and the long-term vision, and belief we have in our strategy in the team we are building here at Energy Vault. We are all results-driven management team and are all laser-focused on creating long-term shareholder value, and maintaining a disciplined capital allocation approach to ensure profitable growth.\n\nTo wrap up, I'm very pleased with the commercial progress we have made across our gravity and the new capabilities we unlock for customers with our new EVS platform. Stay tuned for more exciting announcements to come as we continue to be actively engaged in advanced discussions for multi-gigawatt hours of projects across four continents. I will now turn the call over to David Hitchcock, Energy Vault, interim chief financial officer, to cover our financial results in more detail, David.\n\nDavid Hitchcock -- Interim Chief Financial Officer\n\nThanks, Rob. Relative to our financial results for the second quarter of 2022, revenue in the quarter was $1 million, reflecting construction support services to support the 100 MWh project in Rudong China. Second quarter gross profit was $0.4 million, driven by the construction support services revenue. Through six months, we reported revenue of $43.9 million driven by the Atlas license agreement booked in Q1 and gross profit of $43.3 million.\n\nTotal operating expenses were $22.4 million in Q2, roughly flat with the $22.1 million reported in Q1 of this year. Stock-based compensation was $6.7 million in Q2, down $2.5 million versus Q1 2022. Excluding stock-based compensation, operating expenses were up $2.8 million versus the first quarter. Sales and marketing costs for the second quarter of 2022 were $1.9 million compared to $2.6 million in Q1 of this year.\n\nExcluding stock-based compensation, sales and marketing expenses were down $600 thousand versus Q1, driven by a decrease in marketing costs related to the IPO. Research and development costs for the second quarter of 2022 were $9.8 million compared to $9.7 million in Q1 of this year. Excluding stock-based compensation, R&D expenses were $900 thousand versus Q1 driven by an increase in EVX\u00a0 test bed activities. G&A for the second quarter increased to $10.7 million compared to $9.8 million in Q1 of this year.\n\nExcluding stock-based compensation, G&A was up $2.5 million versus Q1, driven primarily by cash compensation, professional fees, and personnel, and recruiting costs. In total, we ended the quarter with 129 headcount across the company, up 38 heads or 42% versus March 31st. As we continue to build out the team to deliver for our customers and execute as a public company. In line with our business plan, we expect that our operating expenses will continue to increase on a sequential basis, as we further expand globally and invest in the overall growth of the business.\n\nOperating income for the second quarter of 2022 was a -$22 million compared to a positive +$20.8 million in Q1 of this year, driven by the lower revenue and margin as we recorded $42.9 million of licensing revenue in Q1. Through six months, our loss from operations was $1.1 million. Second quarter 2022 adjusted EBITDA was a -$14.2 million compared to a positive +$31.2 million in Q1 of this year. Our earnings release in 10-Q, which we filed this morning, included a bridge from net income to adjusted EBITDA.\n\nThe key non-cash or non-recurring items that we added back are the $6.7 million of stock-based compensation, and the $14.6 million gain reflecting the change in fair value of our warrant liability relating to our public and private warrants. On a year to date basis, adjusted EBITDA is +$17 million. As of June 30th, 2022, we had approximately $299 million in cash and cash equivalents on the balance sheet, leaving us well-positioned to continue to progress toward our growth objectives in 2022 and beyond. In Q2, we used $10 million of cash from operations, which was partially offset by the cash exercise of warrants in the quarter.\n\nFinally, I am pleased to report that as of August 2nd, 2022, we redeem the $8.9 million of outstanding public warrants as of June 30th, 2022. Starting in Q4, we will no longer be marking these instruments. We still have the $5.1 million of private warrants outstanding. I'll now turn the call back over to Rob.\n\nRobert Piconi -- Chief Executive Officer\n\nGreat. Thanks, David. Again, I hope you get a sense from what we discussed earlier in the commercial side of how pleased I am with the progress that the team has made to the first half of this year, and making substantial gains in advancing our goals, and building out a growth platform with the requisite infrastructure and team to deliver with it. We're very well-positioned now through the second half of 2022, driven by the factors we reviewed above, the most of which are important are three.\n\nFirst, strong customer commercial validation from some of the largest customers in the energy sector. Focused in the highest growth countries and regional market for renewables and energy storage. Strategic investors, who are coincident as customers, and play an active role in helping guide, and support the company through our strategic advisory board, which held its first session this past month in July 2022. I'll also note that this focus on customers and listening to our customers and investors, has served as well as we proved our technology at scale with the first five-megawatt system in Switzerland, and helped influence\u00a0 the evolution of that to our new EVS platform announced back in 2021.\n\nThis has been fundamental that's helped guide our company and keep and maintain our customer focus on the business. Second, a unique and unmatched energy storage portfolio that can serve customer needs across various durations and storage technology mediums, as evidenced by our recent project award announcement. No other energy storage companies are making announcements across both long and short-duration projects. Announcing multi-gigawatt hour development of gravity energy storage projects in one of the largest energy storage markets in the world, in Australia.\n\nAnd our first three EVS project awards from customers totaling another 1 GWh is not something that comes without dedication and a relentless focus on execution while ignoring the noise. And third, and finally, the foundation of all we accomplish as a company every day starts with our people, who share a passion for our mission of decarbonization and most importantly, serving customers. With that operator, we're now ready for questions.\n\nOperator\n\nThank you. [Operator instructions] First question is from the line of Joseph Osha from\u00a0Guggenheim Partners. Please go ahead.\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nHey, good morning, guys, or good evening, or wherever you are. My compliments and all the announcements, I have a couple of questions. First, looking at these Energy\u00a0 Vault solutions wins that you just announced, are they all hardware integration plus software? And if so, I was just wondering if you could give us maybe some rough sense as to what the contracted software revenue might look like for that gigawatt hour of when you just announced. And then I have a couple other questions.\n\nThank you.\n\nRobert Piconi -- Chief Executive Officer\n\nOK. So Joe, great to speak again. We are in New York here, so we're on East Coast time, just so you know. For your first question the answer is yes, that those projects include hardware integration, and software both.\n\nThey'll also include, as you would expect, long-term service agreements in addition to the initial hardware integration and software that gets implemented. Secondly, relative to those three contracts, you can expect something in the range of $350 million or so of revenue across those three specific projects that we referenced today.\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nOK. Are you able to, obviously, some of that, able to talk about contracted software revenue for that, because that's where the [inaudible] is so to speak. Is that something you're able to speak to?\n\nRobert Piconi -- Chief Executive Officer\n\nWe're going to be giving more updates on that, on the software component of that revenue, as we get into the specific customer announcements, we'll be able to share more than with you.\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nOK. The second question is, looking at the remainder of the year and that 75 to 100 million target that you put out there. And then just sort of looking at timing and so forth, should we think about the remainder of the revenue this year coming from our EVS, coming from additional monetization of this first China Rudong project? Or I see you've got to limit your sounds like you're breaking ground on and now, where should we think about the remainder of that revenue coming from?\n\nRobert Piconi -- Chief Executive Officer\n\nYeah, it's going to come from a `combination of our gravity project that we announced, and also some of the start on in particular the of the announced awards on the battery side in Q4. So that's what you can expect for the rest of the year. There would also be some additional revenue REC from the initial IP license and that will continue sort of trickle in for the remaining amounts there.\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nOK. And then the last question that target for next year is quite something, although I think your previous reference to the $350 million may have given me some sense there. To what extent are you able to help us understand that buildup to that? Now it looks like $580 or so million dollars in revenue for next year. And how much of that might be that $350 you just referred to on the EVS side?\n\nRobert Piconi -- Chief Executive Officer\n\nYeah, well, look, so that number essentially, as we stated is reflects, if you look at our first two years, 2022 and 2023, essentially a slight shift from 2022 given the ramp-up of the project into 23. And with everything we see today, both in terms of announced project awards, some of those have pretty quick [inaudible] into the mid part of next year. And so that gives us a lot of confidence relative to the revenue that we put out there. In addition, we have and are in advanced discussions on other projects that we see fairly near term closure on in terms of getting the deals done, that then would impact as well next year.\n\nSo that's what essentially led to our revenue range there.\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nOK. But just, and then I'll go after this question. To what extent can you help us? Maybe, because that's extraordinary, right? You're going from, if you look at this year that was forced, maybe you got another $25, $30 million revenue to $580, that's quite something. So just wondering if you can help us maybe it just a very high level understand what the buildup of that number is for next year.\n\nRobert Piconi -- Chief Executive Officer\n\nFair well, as I said, we have +$350 million from just those some of the additional EV projects. We also have some gravity projects underway, and as you can imagine, we're involved in a lot of customer activity and discussions across our main regions. And I spent some time on the China talking a little bit about China and the development that's going on there. So there's a lot of government support there locally to get renewables deployed there, targets that, of course, China has put out by 2030 and 2060 that they're really serious about.\n\nAnd so our local partners there are really focused. If you listened in a bit on the color I provided, we see a lot of strength and opportunity there and in those markets as well. So I'd say that, we don't take that lightly. It is a very large ramp of revenue, but it is something that we have a pretty good line of sight on just relative to both what we have in awards, as well as the discussions we're having with customers.\n\nAnd as you know, you get a sense of the numbers of the size of these deals? Joe, one thing you imagine you take away there is we are in announcing 50 or 60 megawatt-hour deals. These are multi-hundred-megawatt hours of deals that, again, not something hopefully that is [inaudible] people. So when you look at the size of the projects we focus on, OK, both for gravity, we're focusing on large utility-scale, massive projects. A lot of that's focused too on the industrial segment.\n\nSo I think size and scale matter for our focus, we're not really focused on a lot of smaller deals and getting things done there. It takes a lot of time to get deals done right. We saw that this year. I would have loved to have been contracted a quarter earlier on some of these things.\n\nBut these deals take time to get done, and there's a lot of complexity that customers are facing. So. you got to get it right for safety as well. And the reliability and customers spend a lot of time with us on that.\n\nAnd our teams, our technical teams spend a lot of time working with customers and ensuring they have the right architecture set up so that everything can operate effectively. So anyway, that's the color I give you at this point. And of course, as we get into next quarter and I think we're going to be speaking again in November, we'll have more information to share on our progress as far as project awards and bookings and things that will hopefully shed some more light on as we look at 2023.\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nOK. Thank you so much for the detailed answers. I will step aside.\n\nRobert Piconi -- Chief Executive Officer\n\nThank you very much. Good to speak again as always.\n\nOperator\n\nThank you. Our next question is from the line of Stephen Gengaro from Stifel. Please go ahead.\n\nStephen Gengaro -- Stifel Financial Corp. -- Analyst\n\nThank you. Good morning, everybody. Good morning, Rob.\n\nRobert Piconi -- Chief Executive Officer\n\nHi, Stephen, how are you?\n\nStephen Gengaro -- Stifel Financial Corp. -- Analyst\n\nGood, thanks. So a couple of things for me and I was just going to ask one more on the 23 revenue guide. And that is, if you look at it right now, can you tell us how much is contracted? How much is in advanced discussions? And how much is expected? Because one of the big questions we get is sort of the revenue ramp in general. And since you kind of reiterated your kind of two year cumulative revenue guidance, it would be great to get a sense for the visibility there.\n\nRobert Piconi -- Chief Executive Officer\n\nWell, as I referenced, as we announced some of the new EVS projects, you can think about those and the +$350 million type of range on those. And what's interesting about them, two of the three have made 2023 COE. So that I think that's important relative to as we think about recognition. I mean, these are projects that are urgently needed by the utility, a lot of them in California that have urgent needs.\n\nSo that's on the one side. Obviously, on the battery system side, those deals tend to turn a little more quickly, obviously, because we're not building gigawatt battery factories where you're buying and integrating our software. So those deals tend to turn quickly. And we have, I'd say, in the hundreds of millions of gravity energy storage projects that we see, and those obviously come over longer periods of time because it takes a little longer to build out those systems.\n\nAnd they're larger projects. They're larger projects. So, there's a mix of that. That's about all I want to say, at this point, I think as I mentioned to Joe's question, as we get into next quarter and we'll have better visibility, of course, on the progress through this quarter of bookings and new project awards and be able to shed probably a little more color on your question.\n\nI think we felt comfortable saying something about 2023, even though we're only halfway through this year, just by the nature of what we have underway in awards and project awards and what we have in discussion where we've actually been selected and we're finalizing contractor we've been shortlisted getting through a competitive process. So, it's our first year, our first deployment here this year. So obviously it's a little dynamic, but I feel good about the mix of our portfolio here and what we're looking at for next year.\n\nStephen Gengaro -- Stifel Financial Corp. -- Analyst\n\nOK. Thanks, and when we think about these three projects with sort of battery storage involved, I think it's lithium-ion. Is that a customer decision? Is that an application? And how does that sort of fold in with the overall strategy of the company and the margin profile?\n\nRobert Piconi -- Chief Executive Officer\n\nWell, yeah, these are all customer decisions. So, that's who we work for and that's what our focus is. And in terms of the applications, they're pretty diverse. Some of these customers that we've developed relationships over many years now have shared with us what they're trying to solve for, And they've got, Stephen, they've got both short duration needs, they've got some longer duration needs that are going to be coming, they're looking at hybrid architectures, for example, between long and short duration, and even looking at things like green hydrogen, and hybrid systems with batteries, and looking at a unique ways to solve some of their storage needs, and really ensuring that they're going to have the capacity, the right time.\n\nSo I would say, what's interesting and how core this is to your final part of your question on how is this how does this impact in our strategy? And as with what we're announcing around the software side of our business now. It really became clear to us a few years ago, we started to build our first commercial system at scale on the gravity side, if we were getting feedback from customers, that led to, of course, the development and the shift in the form factor to the new EVS platform. They were also sharing with us what they needed to do to manage both generation. So think about that as wind, solar, as well as in some cases their existing fossil fuel that they're managing in the multiple different storage solutions that they're managing.\n\nSo you think about that complexity, it became very clear to us back in 2019 and through 20 that we really need to accelerate the part of our vision around the role software was going to play in helping our customers evolve and supporting them. And that's what led to some of the priority on us getting the right team in here. With the announcement back in November of John Jung and Akshay joining the team [inaudible] that moved quickly and that was nine months ago. And here we're announcing gigawatt hour and project awards alone, I don't know if another company has done that.\n\nSo, that's what I'd say about your question.\n\nStephen Gengaro -- Stifel Financial Corp. -- Analyst\n\nGreat. Thanks. And then just one final one, your original, and I know there were sort of Co-equity investment in a lot of this. So I think that's changed, but your original guidance has give or take [inaudible] million of capital spending in 22 and 23.\n\nAny updates on that? And what the cash use looks like over the next two years?\n\nRobert Piconi -- Chief Executive Officer\n\nYeah. I think. David, you want to want to comment?\n\nDavid Hitchcock -- Interim Chief Financial Officer\n\nFirst of all, provide a little bit of clarity on the rest of this year. As I said in the prepared remarks, we wrapped up the second quarter with roughly $300 million in cash. As we look across the rest of the year and what path we expect to use as we ramp up these initial projects, we expect to end the year with a cash balance between $260 and $280 million. Secondly, when you looked at that original plan, there were a lot of CapEx equity-based deals that the team was expecting at that point in time.\n\nWe really haven't seen a lot of those as the business has worked through this initial year. And there is one project that we're looking at now that could be in that space, but we need to continue to evaluate that and make sure we understand exactly where we want to go there. But there's no projection in front of us right now where we're going to be spending $200 million a year on CapEx for that type of build as expected a year ago. And most of the deals that we are talking now, the customer want to own the project, they want to own the system.\n\nSo the CapEx, our CapEx view, aside from maybe that one project which we can probably shed some light on by next quarter, our CapEx needs are going to be relatively light across the rest of the year.\n\nRobert Piconi -- Chief Executive Officer\n\nYeah. And that's one of the beauties of the business model we have. We're very CapEx light in general. And to just say something, David, that our customers want to own these, but they want to own these projects, and that's I think important for us and just allows us to with this $300 million of cash that we have, as you saw in the quarter, we had very limited cash burn, I think a net $4 million and strong cash into the end of the year and with no debt, of course.\n\nStephen Gengaro -- Stifel Financial Corp. -- Analyst\n\nGreat. Thank you for all the color. Appreciate.\n\nRobert Piconi -- Chief Executive Officer\n\nThank you, Stephen.\n\nOperator\n\nThank you. Our next question is from the line of Thomas Boyes from Cowen. Please go ahead.\n\nThomas Boyes -- Cowen and Company -- Analyst\n\nThanks for taking my questions. A couple of them. First, given the progress in China, I just wondering if you could talk about what your expectations are around construction and commissioning of the change at all from initially? You know, that was like 12 months or something to the facility, but still fair expectation.\n\nRobert Piconi -- Chief Executive Officer\n\nYeah. I think we said, I think for the first time now that we're expecting in Q4 now mechanical completion of that first hundred megawatt-hour system. So they really are progressing well even with the Shanghai lockdown that they had. So they, as we mentioned, have over 1200 piles in the ground now in our start in the foundations now next month and are going to be coming up out of the ground.\n\nSo, we're really happy with what we see in the progress there, not only on the core project comments, but as we mentioned, and I gave some color, quite a bit of color on the development activities that stretch across some of the state-owned entities there on the utility side, as well as some of the regulatory groups that are supporting the technology development and implementation of new storage technologies there. So it's great to be on the ground floor there as the storage markets are developing, and as China is putting much more emphasis on the shift to renewables. So, anyway, so we see everything moving well there, we are going to be, as I mentioned in my opening remarks, more involved as we get into the commissioning activity. We are opening a wholly owned foreign entity there that just gives us a lot more flexibility, I think, to support the local markets, work with China Tianyang in there, and Atlas renewable and more broadly support other regional markets where we can leverage China where it makes sense.\n\nThomas Boyes -- Cowen and Company -- Analyst\n\n[Inaudible] maybe just to kind of build off of that since construction is going well over there. But it's happening at a time where there is inflationary pressures and for cost of construction, what learnings have you had at that, that builds that you think that you could translate as far as controlling costs in the U.S. or Australia?\n\nRobert Piconi -- Chief Executive Officer\n\nThat is a great question, and really, this has played so well for us in having our first full EVx scale system being developed and built there. We're obviously using a local supply chain there, 100%, 200% local supply chain for all the materials, all the power electronics that we're we're implementing there. And we're learning a few different things you mentioned, there's things on what we're seeing on the cost side, and the core material cost in power electronics. That's been very helpful with the local China supply chain.\n\nBut in addition, one of the things we're doing with this system is we're implementing some of the newest cost reduction and new architectures right away, so right out of the gate. So our roadmap of activity that we look at from a design perspective in things like eliminating some of the infrastructure out of the power electronics side, for example, out of our end into our lifting mechanisms for the system, looking at how we are looking at the foundation and the piling activity, and looking at construct ability, looking at optimization around how we construct the system, all of those things we're implementing into this first system, that then we'll be learning. And you rightfully mentioned Australia, so it's a very interesting sequencing here that we're going to be first and have a lot of learnings, I'm sure, as we get into the commissioning of the first EVx system. I think the good news is it's not a small system.\n\nI mean, it is a large 25 megawatt, it's a 4-hour system, a hundred-megawatt hour. So all of those learnings, I think, are going to translate into what we're looking at in a very large and evolving market in Australia, for example, from a local region perspective. But the other learnings are going to come for all of our global deployment and in EVx all over the world, including the U.S.\n\nThomas Boyes -- Cowen and Company -- Analyst\n\nI appreciate it. If I could sneak one more in the jump back in the queue. Just give us some insight into what kind of opportunities that you're seeing over this next 18-month period as far as it relates to duration. My assumption is that it's still probably mostly in the 2 to 4-hour range.\n\nBut I was just wondering if that's true or maybe if there's longer duration systems that are kind of in the pipeline for where you have your guidance that.\n\nRobert Piconi -- Chief Executive Officer\n\nYeah, it's interesting. We probably can uniquely answer that question given where we're playing across short and longer duration. Right. So this is a really interesting question.\n\nThe market continues to be in the bulk of the market. And you can look at all the market data focused in more the 2 to 4-hour range. Now, while saying that what I see about us, in our customer base, remember that the strategic investors we have in BHP, for example, the Korea Zinc Group, which include includes Ark Energy and Sun Metals, that has a stated strategy of being one of the largest green hydrogen producers out of Australia, groups like Saudi Aramco. So when you look at these types of investors that are coincident with customers, the industrial players are making this transition.\n\nAnd a lot of that's going to require the production of green hydrogen. That's going to mean longer duration storage of at least eight and typically up to 12, I think we announced with DG Fuel's a 16-hour storage, you need that longer duration because you're driving a process of electrolysis with an electrolyzer where you're splitting water and making green hydrogen. So because of that, on the industrial side, you have to have something that's 8 to 12 hours. You better not degrade because it's going to get way too expensive.\n\nAnd that's where our gravity really comes in, in place strong and really, there's just not a lot of scalable, and low cost, long duration storage technologies. There's a lot of development, there's a lot of new solutions that are in process of getting to a first demonstration. We were ahead of the game, I think in this case with our first five megawatts system in Switzerland that we in 2019 went right. Right to market to prove the technology at scale, and that's what led to all the diligence that we had from some of the largest energy groups in the world that I just mentioned that did the diligence on the tax, all working and working as planned.\n\nI saw the round efficiency we were achieving in Switzerland there, and that led to the progression and getting to their needs for longer duration storage. So it's a little bit of a mixed bag given our specific customer set that we work with. And on the industrial side, I'll say and also with players making, for example, sustainable aviation fuel. So, those type of projects, while they're longer term and a little bit further out, I think, I mean, these are things that are getting developed over multiple years.\n\nThey're very large in scale, so we're going to see more and more on that longer duration play in our portfolio in the coming years. And it's going to be a ramp as we get that industrial segment up and going. And the great news for us is we've got with our new software platform the ability to help our customers develop and implement shorter duration solutions with the same type of software platform.\n\nThomas Boyes -- Cowen and Company -- Analyst\n\nNow perfect. Thank you so much. And jump back in the queue.\n\nRobert Piconi -- Chief Executive Officer\n\nAll right. Thank you, Thomas.\n\nOperator\n\nThank you. Our next question comes from the line of Brian Lee from Goldman Sachs. Please go ahead.\n\nBrian Lee -- Goldman Sachs -- Analyst\n\nHey, guys. Good morning. Thanks for taking the questions. Appreciate all the high-level color and kind of thoughts around the market,\u00a0 it's really visionary kind of what you guys are doing and all the momentum you have here.\n\nBut I have a couple of sort of more, I guess, nuts and bolts types of questions, just as I think about the model here and all the moving pieces. So maybe first off, on the margins, this battery storage, all these project wins quite impressive in terms of scale and timing. But it's not your technology, it's not the gravity storage, and we see players like [inaudible] and others barely maintaining single-digit gross margins on these types of deployments across the software piece of the business. So I guess the question is, what are you going to make margin lines on being a battery storage deployment company for that kind of $350 million of revenue opportunity versus what you might make on a similar $350 million where you're selling the EVx systems? That's my first question.\n\nAnd then I have a couple of follow-ups.\n\nRobert Piconi -- Chief Executive Officer\n\nYeah, well, look, let me also, as I did in gravity, I provided a lot of color and on the types of projects. But let me do the same a little bit on the battery side, because I wouldn't look at us and put us in the bucket of, for example, fluence necessarily. The types of projects that we're looking at, and the problem for solving for customers are pretty complex where they need, for example, they have limitations on space, for example, so they need more creative solutions than exist in the market for energy density. So that puts some of the players that you might expect sort of out of that equation if they can't support certain architectures.\n\nWe also in these projects, we've announced are putting in place architectures that in some cases represent hybrid of a combination of technology. And we'll be able to share more details on that. And then, we obviously are doing things with our software. And on the service side, that being at the beginning here, Brian, obviously, it's a little early for me to give you an expectation on that, because we're not a five or ten year player in that space.\n\nObviously, we're just announcing these new project awards. We're going to be executing on these here in the starting Q4 and through to 2023. And we'll be able to give, I think, a little better indication on that opposed post our Q3 quarter.\n\nBrian Lee -- Goldman Sachs -- Analyst\n\nOK. I mean, maybe a simple question just since you are benchmarking the initial financial model 22 slippages is feeding into a better 23 for the aggregate 22, 23 revenue is in line with what your prior financial model was targeting. Would you say the same about margins given this mix shift, which seems to be playing out as well?\n\nRobert Piconi -- Chief Executive Officer\n\nSure. Well, what I say is, based on what we're seeing in the ramp-up on both on the gravity side and even within the battery portfolio. That mix now is going to have an impact, I think, on what we had historically in our business plan before, because we have a little different mix of things. We have some things on the positive side, Brian, because I think pointed this out as we talked before, we have the ability to license the technology in particular.\n\nObviously, that means gravity in some place of the world that we had. We had always assumed we were going to be doing some of that. We obviously got a little bit earlier on as a start, which is always nice to have, is a deal like we had with Atlas in China. So that was obviously a little larger earlier than we had anticipated.\n\nSo those types of things will be helpful to our overall margin profile. I think on the new, as we ramp on build out gravity now, and then deal with some of the supply chain areas and just the demand on for example, the EPC companies alone. So I think one of the things I'll give you some color on as we look at early margins, you've got EPC companies that all are very, very busy. Number one, anytime they're going to build something new, and I'm speaking gravity now, so they're building these integrations of lifting systems, and power electronics, and things that have not been built before.\n\nWhat we saw in the mid-part of the year on some of the quoting we had done was a lot having the EPC companies build in just a lot of contingency, and a lot of things for the unknown on the Labor side, for example. And that shifted a bit. Therefore our strategy on what we were going to start to be involved in meaning, for us to be a little more involved therefore in some of the innovation on the construct ability side. So I'd say from a margin profile perspective, we're going to be taking in factoring this new mix into the rest of this year and into next year.\n\nNow, we provided a little bit of the EBITDA, adjusted EBITDA guidance, I know we didn't give any guidance yet on the specific unit economics, but I am expecting an impact to that gross margin to be slightly lower than what we've had out there relative to this new mix as we look at 2023. But we're going to be getting more information on that here over the next quarter and as we actually start executing projects. I think that's key because we're actually going to be building recognizing revenue against these projects, and we'll be in a better position with every quarter here. And that's part of being a new company that's deploying new solutions as planned for our first deployment year.\n\nAnd also some of the longer time-frames on the gravity side to have those built out. I mean those projects are 9 12 plus months for the first systems, and can be longer if we get into the 500 MWh plus which some of those projects are. So I know that's not exactly the in-depth clarity, but just to give you some indications, we're going to be absolutely having to update our mix across, I'd say those three areas, licensing, gravity, and our EVS sort of integration platform. And that's not only going to be batteries.\n\nSo, we're going to be updating that mix and be able to provide hopefully a little more granular level as we get post Q3.\n\nBrian Lee -- Goldman Sachs -- Analyst\n\nUnderstood. I appreciate the direction now. And, you know, there's more things to kind of get ironed out here before you reveal the specifics. So that's helpful, though.\n\nMaybe last one just again, kind of logistically, and I'll get back in the queue. Can you talk about for these large project awards you're announcing today the three battery storage, who the battery suppliers are? I mean, the COD and mid-23 is great because it means you have real line of sight to these projects moving forward. But have you secured the supply with sort of your situation on the ground in terms of lithium-ion battery suppliers, pricing those contracts out, getting the delivery schedule? Thank you, guys.\n\nRobert Piconi -- Chief Executive Officer\n\nSure. Look, we aren't going to provide specific names of the battery players. Just know that we're working with some of the most well-known players in the world there. We've also done a lot of development work on our own there.\n\nI mean, China's a presence for us, as you can imagine, for the last few years of what we're announcing the last year, obviously, as a result of us spending significant time in the region. So, I would say that we are looking there to leverage the market as best we can, as well as do some development between some players there that are doing some unique things. I think on the battery technology and how that integrates with some of the things we're doing in software. For everything we're going to be doing, Brian, I hope you get a sense, we're never going to be need to.\n\nWe look at everything is how we innovate and do something to provide value to customers that they aren't potentially finding in the market, and that innovation isn't just there because we want to say we're doing something cool, that is all about unit economics. That is all about unit economics, if you're going to differentiate and do something that others can't, there's a premium you can extract, or you're doing something more cost-effectively at the market price to really focus on that, and drive in that economically, both for our customers and for us, quite frankly.\n\nBrian Lee -- Goldman Sachs -- Analyst\n\nThanks so much, guys.\n\nRobert Piconi -- Chief Executive Officer\n\nAll right. Good to chat, Ryan. Thank.\n\nOperator\n\nThank you. Our next question comes from the line of Noel Parks from Tuohy Brothers. Please go ahead.\n\nNoel Parks -- Tuohy Brothers -- Analyst\n\nHi. Good morning.\n\nRobert Piconi -- Chief Executive Officer\n\nHey. Good morning. How are you?\n\nNoel Parks -- Tuohy Brothers -- Analyst\n\nReal good, thanks. So just thinking about some of the comments you were making about implementing technology improvements as you go, for example, to the project in China. I just wondered, could you maybe just talk a bit about what may be in motion technology-wise, either, whether you're talking about implantation construction or even all the way back to further progress on the material side. So just to give an idea of what's kind of being upgraded as you, or getting more attention of you as you go along with implementation and then design for the next raft of projects.\n\nRobert Piconi -- Chief Executive Officer\n\nYeah, it's a great question. So let me start with gravity. And if you look at our gravity solution and think about the buckets of where our cost is. It starts with the fixed frame in the foundation.\n\nSo if you just think about your building a house, right? That's what we're building as a structure. So that starts with that foundational element where I think I mentioned this before, but we're working with some of the leading research players in civil engineering. So for example, from Caltech, we have the chair of their seismic in civil engineering group, Dr. Jose Andrade, that joined the company a year ago, and is dedicated with us because of the nature of what we're doing as we build these structures and build them across different type of geological profiles.\n\nSo that's a chunk of the cost that we really look to get at and innovate, and that includes looking at alternative materials. OK. Then that fixed frame component in particular, there's a lot of different ways you can structure a building. You can use steel, you can use prefabricated concrete, and there's also a lot of different ways you can get at that construct ability costs, which as I mentioned to one of the earlier questions from one of the analysts.\n\nThis aspect of the time to construct and how you optimize to shrink that time frame, how do you automate to minimize that labor component? Well, while that labor component is as much lower cost in places like China, and other places like the U.S., it's very, very high, especially in this market, especially in this market. So if we can innovate and provide a way to automate the building of these fixed frames, for example, in components and prefabricated sections and using automated trolleys, for example, that can leverage the infrastructure of the system itself. There's a lot of things that we're looking at there to address that bucket of cost. And of course, with the first system in China, we're going to be looking at how these things play out in ways to optimize it, because we're going to be learning, we're going to be learning on the first build.\n\nThere's a second piece around the Power Electronics. It's the other chunk of cost and that's all that the motors, inverters, variable frequency drive. And in our case, in the gravity side, we have these lifting systems, the vertical lifting system. So think vertical freight elevators, right? And the large ones that are lifting essentially 25 metric tonne blocks, which are that sure and posit block.\n\nSo that's another area that we look at innovation in there, that gets down to hardware elimination, meaning coming up with architectures where we eliminate gearboxes, or the active front end, or the variable frequency drives in favor of mechanical systems that work differently, for example, in the process of how we're lifting objects. So I think there's a hardware meaning, think about that is CapEx right for customers. So trying to reduce and get a debt that CapEx equation to take hardware cost and coming out, there's obviously a volume component of that. So if we look at multi-megawatt motors and try to look at innovation in that space, that's an area that we'd like to ought to honestly see more innovation, and therefore lower cost, and more efficiency.\n\nWe're using motors that are going to be anywhere from 96% to 98% plus in terms of efficiency there for a portion of the architecture. So I think we're balancing innovation there to take material cost out, as well as to improve [inaudible] efficiency. And that improves economics, right? Because what does that mean? That means for every unit that you store, we're able to return more of that unit without loss back to the grid. So a higher [inaudible] efficiency means there's less loss in that process.\n\nSo that's what I say around this second part around the power electronics and fixed frame. The third have to do with these mobile masses that get built. So those are these composite, but these, you know, 25 metric ton composite blocks. There are thousands of them per system.\n\nSo you can imagine as we eliminate that using concrete, so this is part of our focus on sustainability, but as well as cost, we aren't using concrete in the production of this composite block, we're using as a default solutions soil, so that's available locally. In addition, we can use waste materials and where we can do that, we're going to try to do that. Things like coal ash tailings from the mining process, and as we announced with integrated power, looking at the integration of wind blade, decommissioned wind blades and that fiberglass that otherwise have to be burned or buried. So right, I recycle that.\n\nSo those are the areas around cost that we try to get in gravity, and then what I'd say about EVS, as I mentioned this to the last question, also that I think Brian had, but also that Stephen touched on is we're looking at trying to innovate to do things between the battery suppliers and our software in a way, and helping customers solve some of their complex problems that can help us take cost out of the overall solution and provide something very valuable to customers. That includes, by the way, looking at different hybrid architectures to uniquely provide, for example, backup systems with multiple technologies. And we'll be sharing more about that in the future here as we execute.\n\nNoel Parks -- Tuohy Brothers -- Analyst\n\nOK. Great. And you know, one thing as you talk about, and I just trying to picture projects that are in construction all the way out to the various horizons of planning and expecting scaling to find the requirements. So as far as lead time, there must be a point where it's kind of a drop dead with the plan as far as we're not going to try to add anything innovative for the six months or whatever before the trial to start.\n\nCan you give us a sense of how the timing of that happens when you're trying to integrate these advancement into a project?\n\nRobert Piconi -- Chief Executive Officer\n\nYeah. By the way, it's a great question, and it's also a balance. So as we sign contracts, they have deadlines, they have [inaudible] that we have to respect. And our customers have those.\n\nObviously, those same constraints relative to hitting number. So what does that mean? For example, for our project that we're implementing in places like the U.S., we have to get started. So that means that we might be a little more conservative with the materials to start, to make sure the technology is proven on first deployments. You can translate that into higher cost, because we may not have tested yet some of the new innovation in cost reduction.\n\nSo as I mentioned, we're excited about where China is because we are going to be implementing new testing at commercial scale, large commercial scale. Some of that we're doing testing in Switzerland. We have a test bed for our EVx systems there where we're looking at a few different new cost reduction methodologies there, for example, for the trolleys and even for the lifting systems. So there is a balance and we do have to just essentially go with what we have at a certain point and know that we're going to have a road map to get there.\n\nAnd that's why we capitalize the company the way we did. David mentioned this, and when someone asked about CapEx in our original plan, we had, I think over the three year period, over $350 million of planned equity investments for projects at that time, thinking that we were going to be participating in projects in a much bigger way with our balance sheet. What what's happened and has things evolved is we aren't needing to do that. So we're actually have very, very minimal.\n\nI mean, as David mentioned, we only have one project right now where we're looking at building that out on our balance sheet, and we'll be sharing more about that over the quarter. So I'd say that the implementation of where we're going of the cost reduction roadmap and the decisions at a certain point, we do have to make decisions and we go that and execute for customers. And, you know, the last thing I'll say on timing is just getting through the contracting process. I mean, as I said, we very just candid and transparent with you.\n\nWe were hoping to get some of these project awards 2 to 3 months earlier this year, and that's just a fact. We were hoping to have some of them even before June 30th. And it just some of these contracts have taken a little bit long, we're happy to talk about them now. So we were happy to actually talk about project awards so that we couldn't do that last quarter, because we're just working through that contracting process.\n\nAnd again, that's not new to any of us around this table. We have a very seasoned management team that's been in a sector in industry. So we get it on what it takes to get customers across the line. I will say that we're solving some pretty complex problems for them that results in a lot of engagement of our technical teams to help do that.\n\nBut that's why they choose us, and then we get through the contracting process because they see the value of the innovation, how we're creatively solving this problem.\n\nNoel Parks -- Tuohy Brothers -- Analyst\n\nGot it. So it's still very much a very dynamic process. And it's not as if there is an off-the-shelf installation you can outline to somebody and do a contract and you're done. It sounds like, as you said, a lot of involvement from the technical team just to even get to the contract.\n\nRobert Piconi -- Chief Executive Officer\n\nYeah, but the way, not unexpected again. So just to be clear that we expect that and we always start fairly standard, and then we get into specifics. But that's part of the value add as well. I mean, for the gravity systems, I'd say that we have a cookie cutter way to just I mean, a modular thing just to go out and build it.\n\nOK. So that's for gravity, it's more of doing geotech insight, a lot of work on the site because we're building a building, right? So that's where some of the work that gets done upfront. So that's a more modular build out. I think as we get into what we're using our EVS software for in solving those problems, we and we get into different technologies that we're integrating.\n\nThat's where there's just a little more both creativity and complexity. But that's the value we add, and that's why we're getting chosen and selected here for these larger projects.\n\nNoel Parks -- Tuohy Brothers -- Analyst\n\nGreat. Thanks a lot.\n\nRobert Piconi -- Chief Executive Officer\n\nOkay. Thank you, Noel.\n\nOperator\n\nThank you. Ladies, and gentlemen, at this time, we have reached the end of the question-and-answer session. And now I would like to turn the conference over to Mr. Robert Piconi\u00a0for closing comments.\n\nRobert Piconi -- Chief Executive Officer\n\nOK. Great. Well, look, I want to thank everybody for joining our call today. We're really excited with what we've discussed today across the gravity front, and the progress we're making in our focused three regions that we outlined at the beginning of the year.\n\nAnd that's the U.S., China, and Australia. We have a lot of activity going on globally. We're very measured and focused as a company to ensure that we focus on these first deployments of our EVx platform, as well as the new deployments now with our EVS team, that the first ones are very successful. And while I know the numbers are large, as we've discussed some pretty large ramp here, revenue revenues, we look into 2023.\n\nIt does reflect a very focused effort on specific regions and specific customers. And if you got a sense of the size of the deals we mentioned, I think that's a real benefit. Meaning we aren't doing 30 deals, or even 20 deals, or even 15 deals. We are focused on large projects with large customers that have a lot of credibility and are making choices, as you heard today, for our technology.\n\nSo I think that's definitely a benefit, it's a strength, it allows us as both a commercial and an operational team to keep focused on few but important things. I think less is more in that regard, and that's going to help drive success as we scale and ramp up. And learn, by the way, so these are going to be first deployments that brings with it some level of execution risk. At the same time, if you look at the management team around the table and I always want to end on this now with the people and the team we've assembled, I really believe we have one of the most experienced, dedicated, motivated, and passionate teams focused on decarbonization, but really, really focused on listening to our customers.\n\nAnd that's why you get the nature of being able to announce project awards of this size and with these type of customers. And we have a lot in the hopper here. And I look forward to share more here as we get back together next quarter. So thank you, everyone, and enjoy the rest of your day.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nLaurence Alexander -- Chief Marketing Officer\n\nRobert Piconi -- Chief Executive Officer\n\nDavid Hitchcock -- Interim Chief Financial Officer\n\nJoseph Osha -- Guggenheim Partners -- Analyst\n\nStephen Gengaro -- Stifel Financial Corp. -- Analyst\n\nThomas Boyes -- Cowen and Company -- Analyst\n\nBrian Lee -- Goldman Sachs -- Analyst\n\nNoel Parks -- Tuohy Brothers -- Analyst\n\nMore NRGV analysis\n\nAll earnings call transcripts"}
{"id": "00c11b1a-8926-442a-97c4-e766f50d6573", "companyName": "SuRo Capital Corp.", "companyTicker": "SSSS", "quarter": 3, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2021/11/04/suro-capital-corp-ssss-q3-2021-earnings-call-trans/", "content": "SuRo Capital Corp.\u00a0(SSSS -0.27%)\nQ3\u00a02021 Earnings Call\nNov 03, 2021, 5:00 p.m. ET\n\nOperator\n\nGood day, ladies and gentlemen, and thank you for standing by. Welcome to SuRo Capital's third quarter 2021 earnings conference call. [Operator instructions] Following the presentation, the conference will be open for questions. This call is being recorded today, Wednesday, November 3, 2021.\n\nI would now turn the conference over to today's speaker, Jackson Stone of SuRo Capital. Please go ahead, sir.\n\nJackson Stone -- Investor Relations\n\nThank you for joining us on today's call. I'm joined today by the chairman and chief executive officer of SuRo Capital, Mark Klein; and chief financial officer, Allison Green. Please note that a slide presentation corresponding to today's prepared remarks by management is available on our website at www.surocap.com under investor relations' events and presentations. Today's call is being recorded and broadcast live on our website, www.surocap.com.\n\nReplay information is included in our press release issued today. This call is a property of SuRo Capital. Any unauthorized reproduction of this call in any form is strictly prohibited. I would also wish to call your attention to customer disclosures in today's earnings call -- in today's earnings press release regarding forward-looking information.\n\nStatements made in today's conference call and webcast may constitute forward-looking statements, which relate to future events or future performance or financial condition. These statements are not guarantees of our future performance or future financial condition or results and involve a number of risks, estimates, and uncertainties, including the impact of COVID-19 pandemic and any market volatility that may be detrimental to our business, our portfolio companies, our industries, and the global economy that could cause actual results to differ materially from the plans, intentions, and expectations reflected in or suggested by the forward-looking statements. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including but not limited to those described from time to time in the company's filings with the SEC. Management does not undertake to update such forward-looking statements unless required to do so by law.\n\nTo obtain copies of SuRo Capital's latest SEC filings, please visit our website at www.surocap.com or the SEC's website as -- at sec.gov. Now, I'd like to turn the call over to Mark Klein.\n\nMark Klein -- Chief Executive Officer\n\nThank you, Jackson. Good afternoon and thank you for joining us. We are pleased to share the results of SuRo Capital's third quarter 2021. This has been one of the most exciting quarters to date for our firm, including notable exits and exciting investment opportunities in multiple different verticals.\n\nThis quarter, three additional portfolio companies announced their intentions to become publicly traded to a SPAC merger, making a total of five SPAC merger announcements in 2021. In addition to the SPAC mergers, three of our portfolio companies announced intentions to be acquired and two had completed acquisitions as of quarter-end. As we make notable exits, we are excited to deploy capital in compelling, new, high-growth opportunities and have added seven new companies to our portfolio in this quarter alone. I am excited to share more details on these events before handing the call over to Allison Green for a brief financial overview.\n\nAt the conclusion of our remarks, we will open the call for questions. Let's start with Slide 3. This quarter, SuRo Capital again reached our highest dividend-adjusted net asset valuable -- value per share since inception, surpassing the records we set in both Q2 of 2021 and Q1 of 2021. At the end of the quarter, SuRo Capital had a net asset value of approximately $426 million, or $14.79 per share, which was near the top of the anticipated range that we posted in our prerelease.\n\nThe $14.79 per share net asset value is inclusive of a $2.25 per share dividend declared and paid during the quarter. This net asset value per share represents a $0.48 increase from the $14.31 dividend-adjusted net asset value at the end of the second quarter. Consistent with our desire to be shareholder-friendly and our continued practice of distributing realized gains, on November 2, 2021, SuRo Capital's board of directors declared a $2 per share dividend to shareholders and approved an extension of the share repurchase program to October 31, 2022. This dividend will be payable on December 30, 2021, to shareholders of record on November 17, 2021.\n\nOur board is again offering shareholders the option to elect to take as much as 100% of their dividend in stock and has capped the aggregate cash dividend to 50% of the total dividend payable. This brings the aggregate dividends declared or paid in 2021 to $7.25 per share. Later in the call, Allison will walk through in detail the election process of this cash and stock dividend. Depending on the portfolio activity for the remainder of the year, the board will evaluate declaring an additional dividend payable in January of 2022.\n\nPlease turn to Slide 4 for a review of our Top 5 positions. SuRo Capital's Top 5 positions as of September 30 were Course Hero, Coursera, Forge, Nextdoor, and Blink Health. These positions accounted for approximately 54% of the investment portfolio at fair value. Additionally, as of September 30, our Top 10 positions accounted for approximately 73% of our portfolio.\n\nFirst, I want to highlight our investment in Course Hero, now our largest position. Over the last year, Course Hero has focused on growing their platform's community and pursuing acquisitions that expand their already comprehensive catalog of students' study materials. This initiative began in October 2020 with their acquisition of Symbolab, a platform that helps students solve complex mathematical equations; and continued in June 2021 with their acquisition of LitCharts, a platform that helps make learning literature more accessible. Since then, Course Hero has grown their offerings by acquiring QuillBot, an AI writing tool that helps people reconstruct their writing to be more concise; and CliffNotes, a library of literature study guides.\n\nBefore the two most acquisitions, TechCrunch estimated Course Hero would hit between 2 million and 3 million paid subscribers in 2021, up from 1 million subscribers last year. We believe these acquisitions will further bolster paid subscriptions and support current Course Hero's goal of becoming the leading comprehensive platform for study materials. As previously discussed, on March 31, our second-largest position, Coursera, executed an initial public offering and began trading on the New York Stock Exchange. Coursera priced at $33 per share at the top of their range.\n\nIn the third quarter alone, sales of our public shares of Coursera had generated nearly $33 million of net proceeds and approximately $28.5 million in realized gains. To date, monetization of our position in Coursera has generated nearly $112 million in net proceeds and over $96.3 million in realized gains. We have sold substantially all of our Coursera investment. We anticipate selling the de minimis remainder of our Coursera position in the coming days.\n\nIn addition to Course Hero and Coursera, we have also seen strong performance from our overall portfolio. During the third quarter, three portfolio companies announced pending SPAC mergers, one company completed a SPAC merger, two companies announced or completed an IPO, and two companies were acquired. During the third quarter, Forge, Aspiration, and Nextdoor announced plans to merge with SPACs. On September 13, Forge announced a plan to merge with Motive Capital, a fintech-focused SPAC, at a combined equity value of up to $2 billion.\n\nEarlier this year, Forge was valued at $700 million post-money, making this deal their unicorn debut. This pending transaction resulted in a $10.5 million write-up or over a 100% increase in our valuation of Forge compared to last quarter. The Forge-Motive Capital SPAC merger is expected to close in the fourth quarter of 2021 or as late as the first quarter of 2022 and resulting gross proceeds of $532.5 million for the combined company. Between January 1 of 2018 and June 30 of 2021, Forge has seen a 225% increase in its customer base and a 114% increase in distinctive private companies traded.\n\nWith nearly 400,000 registered users and 123,000 investors, Forge has driven over $10 billion in volume across 19,000 transactions. We are excited by Forge's success over the years and look forward to the successful conclusion of their business combination. On August 18, Aspiration also announced a plan to merge with InterPrivate III Financial Partners, a fintech-focused SPAC, at an equity value of $2.3 billion. Aspiration raised a $200 million PIPE associated with this transaction.\n\nThe pending transaction is expected to close in the fourth quarter of 2021 or as late as the first quarter of 2022. Aspiration offers a range of sustainable banking services, credit cards, and investment project -- products and boasts more than 5 million participating members. As of June 2021, the company had a revenue run rate in excess of $100 million and saw a 7x growth in the -- since the past year. We are excited by this milestone for Aspiration and believe they have emerged as a leader of ESG-focused fintech.\n\nFinally, on July 6, Nextdoor announced plan to merge with Khosla Ventures Acquisition II at an equity value of $4.3 billion. Nextdoor raised a $270 million dollar PIPE associated with this transaction. Yesterday, stockholders approved the transaction. The merger is expected to close on November 5, with the combined entity trading on the New York Stock Exchange under the symbol KIND beginning November 8.\n\nIn addition to the SPAC mergers announced this quarter, we saw one portfolio complete their merger and become publicly traded. As previously discussed, on February 11, SuRo Capital portfolio company, Rover, announced plans to merge with Nebula Caravel Acquisition Corp., a SPAC sponsored by True Wind Capital. Stockholders approved the business combination, and the transaction was closed on July 30. The combined entity now trades on the Nasdaq under the ticker symbol ROVR.\n\nThe transaction value of the company at an enterprise value of $1.35 billion and provided approximately $240 million in gross proceeds to the company. Our shares of the public common stock of Rover are currently subject to certain lock-up provisions. We anticipate they will expire during the first quarter of 2022. We are excited by this transaction and congratulate Rover on the successful course of their SPAC merger.\n\nIn addition to SPAC mergers, we saw one company announce and another company execute their initial public offering this quarter. On August 20, NewLake Capital Partners completed an IPO and began trading under the symbol NLCP on the OTCQX. The IPO raised $102 million at a share price of $26 a share. As of September 30, SuRo Capital shares of NewLake are not subject to any lock-up restrictions.\n\nWe will liquidate this position consistent with prior practices as market conditions allow. On October 4, Rent the Runway announced that it filed for an IPO at a range of $18 to $21 per share. On October 27, they priced their IPO at $21 per share and began trading on the Nasdaq under the symbol RENT at a price of $23 a share. The IPO was led by Goldman Sachs, Morgan Stanley, and Barclays and elevated the value of Rent the Runway to $1.5 billion.\n\nWe expect our shares of Rent the Runway to become freely tradeable in early Q2 of 2022 when the lockup expires. In addition to these major milestones, two of our portfolio companies were acquired during the third quarter. On August 30, 2021, Udemy, a recently minted public learning and online teaching platform, announced that it acquired CorpU for an undisclosed amount. On September 2, Kahoot!, a publicly traded global education technology company, announced that it acquired Clever.\n\nAs previously mentioned in our prerelease in late September, reports from multiple sources alleged significant improprieties by Ozy Media. Given these serious allegations, as of September 30, we valued our investment in Ozy Media at zero. The many successful portfolio company transactions completed in third quarter and anticipated to be completed in the near future have provided significant cash flows to fund high growth, well-scrutinized, and promising new investments. During the third quarter, we judiciously added seven new portfolio companies.\n\nOn August 9, we invested $10 million in Orchard Technologies Series D preferred shares. Orchard is a vertically integrated property technology company competing in the trade-in and cash offers market. Orchard's Move First product allows homeowners the ability to buy their home before selling their own home while still unlocking the equity they have built up in their existing home. In the current real estate climate, it's more important than ever to have as few contingencies attached with offers as possible, and Orchard is a market leader in removing these barriers for homebuyers.\n\nOrchard plans to expand to foreign markets in 2022, as well as launch new services to offer millions more buyers a better way to purchase their own dream home. Over the past year, Orchard has doubled their footprint; launched Orchard Insurance; and introduced concierge, a service that repairs and updates homes on the behalf of homeowners before sale and no upfront costs. In September, Orchard announced it has raised $100 million at a valuation of over $1 billion in a round led by Accomplice, with participation with existing investors as well. We have evaluated several business models in the property technology sector and believe Orchard's model solves many of the pain points for consumers with a more capital-efficient and less risky model than iBuyers and other similar companies in the space.\n\nAs such, we believe Orchard is uniquely poised to grow and achieve success in both bull and bear housing markets compared to many of its peers in the prop-tech sector. Please turn to Slide 8. During the third quarter, we also made a $10 million investment in the common shares of Varo Money, Inc. Varo is a nationally chartered bank, developing a branchless, digitally native financial platform to improve the mobile banking experience.\n\nVaro offers various services, including financial insights and analysis of spending, real-time budgeting and forecasts of cash flow, direct deposits, online bill payment, and other financial applications. Varo's target market is the 180 million Americans Varo views as underserved and overcharged by traditional financial institutions. Varo believes traditional banks are unable to profitably serve this massive segment of consumers who have modest or no savings. Due to their legacy cost structure, Varo believes traditional banks must charge fees to avoid losing money on these particular clients, meaning customers with the least money pay the most in fees relative to their assets or their income.\n\nVaro has no monthly account minimum balance, no debit card replacement fee, no foreign transaction fees, no AC bank transfer fees, and no ATM fees on Varo-approved ATMs. In addition, unlike other neobanks who use a sponsor bank model by partnering with smaller banks to help offer banking services, as a nationally chartered bank, Varo can operate at a lower cost structure than other neobanks and can pass along these savings to consumers. In September, Varo announced that it raised $510 million in its Series E equity round at a $2.5 billion valuation. This is according to TechCrunch.\n\nSuRo invested $10 million in the Series E round, which was led by Lone Pine Capital, with participation from investors Warburg Pincus, TPG's Rise Fund, Gallatin Point Capital, and others, including new investors, Declaration Partners and BlackRock. Please turn to Slide 9. As previously discussed, SuRo Capital Sports is a $10 million wholly owned subsidiary of SuRo Capital created to take advantage of the significant [Technical difficulty] in this [Inaudible]. Since inception in March 21, SuRo Capital has been creating a robust pipeline of B2B and B2C players across several key verticals, including affiliates, compliance technology, fan engagement, and differentiated partners -- operators.\n\nIn addition to our initial investment in BettorView, since June 30, we made two additional investments in SuRo Capital first -- Sports. The first is PickUp, which allows publishers to embed prop-like predictions within their context -- content. Users create profiles, allowing them to track the accuracy of their picks and earn prizes from sportsbooks and other affiliates. The gamification of content represents a new era of fan engagement where the experience is now centered around the fan versus the previous iteration of fan engagement centered around shares, likes, and comments in social media.\n\nDuring the third quarter, we invested in PickUp's Series Seed-2 preferred shares as part of the round led by KB Partners and Drive by DraftKings. The second investment, Compliable, provides a compliant software solution that makes managing, maintaining, and completing gaming licenses across multiple states and jurisdictions easy. Compliable software platform and tools provide customers with both significant and cost -- time and cost savings, allowing operators to focus on entering new markets and establishing a presence in the growing sports betting landscape. As the complexity of licensing with the real gaming market continues, we believe Compliable will be an essential part of how operators, vendors, and regulators maintain compliance with a constantly changing and varied regulatory environment.\n\nIn October, we invested in Compliable Series Seed-4 preferred shares as part of their Seed extension led by Bettor Capital. Looking ahead, we believe our portfolio is well-positioned as ever to drive long-term value through both exits and ongoing strategic investments in compelling industries and opportunities not readily available to public investors. We believe our healthy cash balance puts us in a strong position to play against this high volume of attractive opportunities. Thank you for your attention.\n\nAnd with that, I will hand it over to Allison.\n\nAllison Green -- Chief Financial Officer\n\nThank you, Mark. I would like to follow Mark's update with a more detailed review of our third quarter investment activity and financial results as of September 30, 2021, including the recently declared dividend and our current liquidity position. First, I will review our investment activity. Please turn to Slide 10.\n\nDuring the quarter, we invested a total of $31.4 million in new and follow-on investments. New investments during the third quarter include a $10 million investment in the Series D preferred shares of Orchard Technologies, a $10 million investment in common shares of Varo Money, an additional $7.4 million in funded capital cost to complete our $10 million commitment to Architect Capital PayJoy SPV, a $2.5 million investment in the preferred shares of PayJoy, Inc., and approximately $700,000 investment of a total of $2 million limited partner commitment in True Global Ventures 4 Plus investment funds, and approximately $500,000 investment in the Series Seed-2 preferred shares of YouBet Technology doing business with PickUp, and a $250,000 investment in the share units of AltC Sponsor LLC, the sponsor vehicle for AltC Acquisition Corp. 2021 investments through September 30 totaled approximately $70.1 million. Please turn to Slide 11.\n\nThis slide highlights our exit made and proceeds received during the third quarter. Most notably, during the third quarter, we sold 837,181 of our Coursera common shares for approximately $32.8 million of net proceeds, resulting in a net realized gain of approximately $28.6 million. These sales during the third quarter are in addition to the exit of 25% of our original Coursera position at the time of IPO for net proceeds of $30.7 million and a net realized gain of approximately $26.9 million made during the second quarter. I will review our Coursera sales subsequent to quarter-end and to date on the next slide.\n\nOn August 30, 2021, Udemy, a recently publicly traded global education technology company, announced it would acquire CUX, Inc. or CorpU. As a result of the acquisition, we received approximately $6 million for a net realized gain of approximately $2 million, inclusive of approximately $315,000 held in escrow. On September 2, Kahoot! ASA, another publicly traded global education technology company, announced it would acquire Clever.\n\nKahoot! acquired Clever for cash, stock, and other consideration contingent on various earn-out provisions. As a result of the acquisition, we received approximately $3 million in cash proceeds and shares of Kahoot!, resulting in a current net realized gain of approximately $1 million, inclusive of approximately $744,000 held in escrow. Anticipated additional considerations subject to earn-out provisions and other contingencies has not been included here. Additionally, during the quarter, we received approximately $343,000 in proceeds from Second Avenue related to the principal repayment and interest on the 15% term loan due December 2023.\n\nFinally, during the third quarter, we realized approximately $295,000 related to our June 2020 investment in Palantir Lending Trust SPV. These additional proceeds are attributed directly to the equity participation and the underlying collateral. As of today, 512,290 shares of Palantir common stock comprising the underlying collateral to which we retain an equity interest remains to be sold. As of December 31, 2020, the balance of the loan and all guaranteed interests had been fully repaid.\n\n2021 realizations through September 30 resulted in approximately $199.6 million in net proceeds and $171.7 million in net realized gains, or $172.3 million including adjustments to amount currently held in escrow. Please turn to Slide 12. Subsequent to quarter-end, SuRo Capital via SuRo Capital Sports made a $1 million equity investment in the Series Seed-4 for preferred shares of Rebric, Inc., which is doing business as Compliable. This is the third investment SuRo Capital Sports has made since inception in early 2021.\n\nIn 2021 to date, we have invested a total of $71.7 million in new and follow-on investments. We have also made additional realizations subsequent to quarter-end. As previously alluded to, through yesterday, we sold an additional 1,409,090 of our Coursera common shares for approximately $48.5 million of net proceeds, resulting in a net realized gain of approximately $40.8 million. We anticipate monetization of the remaining 100,000 Coursera shares to be completed prior to the filing of our Form 10-Q for the quarter ended September 30, 2021, in the next few days.\n\nThrough yesterday's sales, we have received a total of nearly $112 million in net proceeds, resulting in net realized gains of over $96.3 million from our Coursera position. Additionally, we began monetization of our public common shares with Skillsoft. Subsequent to quarter-end, through yesterday, we sold 18,157 Skillsoft's common shares for approximately $229,000 in net proceeds, resulting in a net realized gain of approximately $48,000. We plan to monetize the remaining 981,843 Skillsoft shares consistent with our prior practices as the market allows.\n\nFinally, subsequent to quarter-end, we received approximately $111,000 in proceeds through Second Avenue related to the principal repayment and interest on the 15% term loan due December 2023. In 2021 to date, we received a total of approximately $248.4 million in net proceeds, resulting in over $212 million in net realized gains. Please turn to Slide 13. Segmented by six general investment themes, the top allocation of our investment portfolio at quarter-end is the education technology, representing approximately 46% of the investment portfolio at fair value.\n\nFinancial technology and services was the second-largest category, representing approximately 25% of the portfolio. The marketplaces category accounted for approximately 18% of our investment portfolio, and approximately 6% of our portfolio is invested in social and mobile companies. Big data cloud accounted for approximately 4% of the fair value of our portfolio. And sustainability accounted for less than 1% of the fair value of our portfolio as of September 30.\n\nPlease turn to Slide 15. We are pleased to report we ended the third quarter of 2021 with a NAV per share of $14.79. A breakdown of NAV per share at the quarter-end is shown on Slide 15 and is consistent with our financial reporting. Most notably, the decrease in the NAV per share during the quarter was largely driven by approximately $2.25 per share attributable to dividends declared and paid during the quarter and $0.07 per share attributable to the issuance of common stock from the stock dividend.\n\nAlso contributing to the decrease were an $0.08 per share decrease related to net investment loss and a $0.52 per share decrease attributable to the change and unrealized appreciation of investments. However, this net decrease is substantially related to the realization of investments during the quarter and offset in net realized gain. These decreases to NAV per share were partially offset by a $1.13 per share increase attributable to net realized gains on investment and a $0.02 per share increase attributable to stock-based compensation. I would also like to take a moment to review SuRo Capital's current liquidity.\n\nWe ended the quarter with approximately $180.8 million of liquid assets, including $108.2 million in cash, $72.6 million in unrestricted public securities. This does not include approximately $9.4 million in public securities subject to certain lock-up provisions as of quarter-end. Our cash balance of $108.2 million as of September 30 consisted primarily of the monetization of various portfolio positions throughout 2020 and 2021 to date. The $72.6 million of unrestricted public securities held as of September 30 represent our shares in Coursera, NewLake Capital Partners, and Skillsoft valued at the September 30, 2021 closing prices of $31.65, $29.41, and $11.69 respectively.\n\nThe $9.4 million of public securities subject to certain lock-up provisions as of September 30 represent our restricted public shares in Rover and Kahoot! valued at the September 30, 2021 closing prices of $13.59 and $7.08 respectively, plus a discount for lack of marketability related to the lock-up provision. On October 27, 2021, the company's board of directors approved an extension of the share repurchase program until the earlier of October 31, 2022, or the repurchase of $40 million in aggregate amount of the company's common stock. Since its inception in August 2017, 4,823,332 shares have been repurchased for approximately $30.4 million, not including the Q4 2019 [Inaudible] offer under the share repurchase program. Under the share repurchase program, the company may repurchase its outstanding common stock in the open market provided that it complies with the prohibitions under its insider trading policies and procedures and the applicable provisions of the Investment Company Act of 1940 as amended and the Securities Exchange Act of 1934 as amended.\n\nAs of September 30, there were 28,781,016 shares of the company's common stock outstanding. In addition to the two dividends of $0.25 per share each declared in the first quarter and the $2.50 per share dividend declared and subsequently paid during the second quarter, on August 3, SuRo Capital's board of directors declared a $2.25 per share dividend to be paid in half stock and half cash on September 30 to shareholders of record as of August 18. As a result of the elections, the total dividend paid to all stockholders consisted of approximately $30 million in cash and approximately $2.3 million in shares of common stock. Through September 30, SuRo Capital has declared and paid a dividend attributable to 2021 in the amount of approximately $131.3 million.\n\nAll 2021 dividends declared to date are expected to be categorized as net long-term capital gains for tax purposes. The related realized gains are attributable to the monetization upon sale or exit of the investments in our portfolio. As Mark mentioned, on November 2, SuRo Capital's board of directors declared a dividend of $2 per share payable on December 30, 2021, to the company's common stockholders of record as of the close of business on November 17, 2021. The aggregate dividend will be paid in half stock and half cash.\n\nHowever, the portion of cash received by individual shareholders making a cash election could be greater than 50%. Shareholders electing or deemed to have elected to receive the dividend in stock will receive 100% of the dividend in shares of SuRo Capital, not including de minimis cash paid in lieu for factual shares. As described more fully in today's press release, the dividend will be paid in cash or shares of the company's common stock at the election of registered shareholders, although the total amount of cash to be distributed to all shareholders will be limited to no more than 50% of the total dividend to be paid in aggregate. Shareholders electing cash may receive a cash allocation greater than 50% depending on the results of all shareholder elections.\n\nThis dividend is being made in accordance with certain applicable Treasury regulations and guidance issued by the IRS that allow a publicly traded regulated investment company to satisfy their distribution requirements from a distribution paid partly in common stock provided certain other requirements are satisfied. We strongly encourage all shareholders to proactively reach out to the bank, broker, nominee, or platform through which they hold their SuRo Capital shares to make their desired election outcome known. Only registered shareholders will be directly mailed an election form by our transfer agent, American Stock Transfer. SuRo Capital does not process any election.\n\nMost shareholders are not registered shareholders and must proactively make their election known to the bank, broker, nominee, or platform on which they hold SuRo Capital shares. Each registered shareholder will have the opportunity to elect to receive the dividend in cash or shares of the company's common stock. Registered shareholders electing to receive the dividend in shares of the company's common stock will receive their entire dividend in the form of shares of the company's common stock regardless of the elections made by any other shareholders. However, the total amount of cash to be distributed to all shareholders electing to receive their dividends in cash will be limited to no more than 50% of the total amount to be distributed to all shareholders.\n\nIn the event the amount of cash to be distributed to all shareholders electing to receive the dividend in cash would exceed 50% of the total dividend, each registered shareholder electing to receive cash will receive a pro-rata portion of the total cash to be distributed based on the number of shares held by each such shareholder. The remainder of the dividend in exit of the shareholders' pro-rata share of the total amount of cash to be distributed will be paid in the form of shares of the company's common stock. The number of shares of our common stock to be issued to shareholders receiving all or a portion of the dividends in shares of our common stock will be based on the volume-weighted average price per share of our common stock on the Nasdaq Capital Market on November 10, 11, and 12, 2021, plus $2 to reflect the declared dividend. The company will cause to be mailed an election form to receive cash or common stock only to registered shareholders promptly after the November 17, 2021 record date.\n\nRegistered shareholders are those shareholders who own their stock directly and not through a bank, broker, or nominee. The completed election form must be received via SuRo Capital Corp.'s transfer agent, American Stock Transfer, prior to 5:00 p.m. Eastern Time on December 17, 2021. Registered shareholders with questions regarding the dividend may call American Stock Transfer at 800-937-5449.\n\nRegistered shareholders who do not make an election will be deemed to have elected to receive 100% of their dividend in shares of the company's common stock. Registered shareholders participating in the company's dividend reinvestment plan will also receive an election form. The investment future of the dividend reinvestment plan will be suspended for this distribution and will be reinstated after this distribution has been completed. Shareholders who hold their shares through a bank, broker, or nominee will not receive an election form from the company and should contact their bank, broker, or nominee for instructions on how to make an election.\n\nShareholders who hold their shares through a bank, broker, or nominee are encouraged to contact their bank, broker, or nominee and inform them of the election that should be made on the shareholder's behalf. If a shareholder's bank, broker, or nominee on the shareholder's behalf does not timely return a properly completed election form by the election deadline, the shareholder will have been deemed to have elected to receive 100% of the dividend in the form of shares of our common stock. Regardless of whether a shareholder receives the dividend in cash, stock, or some combination of cash and stock, the entire amount of this dividend will be fully taxable to shareholders, and SuRo Capital Corp. will report the actual tax characteristics of each year's dividend annually to shareholders and the IRS on Form 1099.\n\nThe date of declaration and amount of any dividend, including any future dividends, are subject to the sole discretion of SuRo Capital's board of directors. The aggregate amount of dividends declared and paid by SuRo Capital will be fully taxable to stockholders. The tax character of SuRo Capital's dividend cannot be finally determined until the close of SuRo Capital's taxable year. SuRo Capital Group will report the actual tax characteristics of each year's dividend annually to stockholders and the IRS on Form 1099 subsequent to year-end.\n\nRegistered stockholders with questions regarding declared dividends may call American Stock Transfer at 800-937-5449. Shareholders who hold their shares through a bank, broker, or nominee are encouraged to contact their bank, broker, or nominee for additional details on how their bank, broker, or nominee will process the election on their behalf. Shareholders will find additional information regarding this dividend in the investor relations section of SuRo Capital's website at www.surocap.com. Year to date, SuRo Capital has declared approximately $7.25 per share to shareholders for total approximate distributions of nearly $188.9 million.\n\nAs Mark noted, the board of directors will assess declaring additional dividends depending on the investment activity for the remainder of the year. That concludes my comments. We would like to thank you for your interest and support of SuRo Capital. Now, I will turn the call over to the operator to start the Q&A session.\n\nOperator.\n\nOperator\n\nThank you. [Operator instructions] And we'll take our first question from Manik Patel with [Inaudible] Ventures.\n\nUnknown speaker\n\nGood afternoon. Thank you for taking my call and the question. Our first question is with respect to the grand waves in the market, which are pertaining to the SPACs and the volatility. How do you plan to manage certain lock-in periods? And then there's a follow-up to that.\n\nI'm asking this because a certain percentage of the portfolio is associated with SPACs and then there's a lock-in associated with that. Thank you.\n\nMark Klein -- Chief Executive Officer\n\nUnfortunately, I don't think I followed the first -- the second part of your question. But in respect to the first part of your question, any SPAC that is subject to lockup is -- be either -- is subject to lockup, and those lockups are laid out quite clearly and highly restrictive. And of course, we abide exactly by the lockups that are put forward. Thank you.\n\nOperator\n\nThank you. And next, we'll move on to Candy [Inaudible] for [Inaudible] Financial Services.\n\nUnknown speaker\n\nHey, thanks for taking my call. Could you tell me what the exact loss or perceived loss at this moment of the Ozy Media investment was?\u00a0\n\nMark Klein -- Chief Executive Officer\n\nOn Ozy Media? It's somewhere slightly north of $11 million. Thank you.\n\nOperator\n\nThank you. And that does conclude our question-and-answer session today. I would like to turn the conference back over to the speakers for any additional or closing remarks.\n\nMark Klein -- Chief Executive Officer\n\nWell, we at SuRo thank all of you to take -- for taking the time for this conference call, for taking -- and for supporting us as shareholders. As always, we're available for any other follow-up. You can contact us directly through our IR portal. Thank you all very much and appreciate the time you spent with us today.\n\nOperator\n\n[Operator signoff]\n\nDuration: 47 minutes\n\nJackson Stone -- Investor Relations\n\nMark Klein -- Chief Executive Officer\n\nAllison Green -- Chief Financial Officer\n\nUnknown speaker\n\nMore SSSS analysis\n\nAll earnings call transcripts"}
{"id": "00cc1216-0fea-4826-87c4-d54618e70686", "companyName": "Tradeweb Markets Inc", "companyTicker": "TW", "quarter": 3, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/10/27/tradeweb-markets-inc-tw-q3-2022-earnings-call-tran/", "content": "Tradeweb Markets Inc\u00a0(TW -0.22%)\nQ3\u00a02022 Earnings Call\nOct 27, 2022, 9:30 a.m. ET\n\nOperator\n\nGood morning and welcome to Tradeweb's third quarter 2022 earnings conference call. As a reminder, today's call is being recorded and will be available for playback. To begin, I'll turn the call over to head of treasury, FP&A & investor relations, Ashley Serrao. Please go ahead.\n\nAshley Serrao -- Head of Treasury and Investor Relations\n\nThank you and good morning. Joining me today for the call are our chairman and CEO, Lee Olesky, who will review the highlights for the quarter and provide a brief business update, our CEO elect and president, Billy Hult, who will dive a little deeper into some growth initiatives and our CFO, Sara Furber, who will review our financial results. We intend to use the website as a means of disclosing material, nonpublic information, and complying with disclosure obligations under SEC regulation FD. I'd like to remind you that certain statements in this presentation and during the Q&A may relate to future events and expectations, and as such, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.\n\nStatements related to, among other things, our guidance are forward-looking statements. Actual results may differ materially from these forward-looking statements. Information concerning factors that could cause actual results to differ from forward-looking statements is contained in our earnings release and periodic reports filed with the SEC. In addition, on today's call we will reference certain non-GAAP measures.\n\nInformation regarding these non-GAAP measures, including reconciliations to GAAP measures are in our posted earnings release and presentation. To recap, this morning we reported GAAP earnings per diluted share of $0.33. Excluding certain non-cash stock-based compensation expense, acquisition-related transaction costs, acquisition- and Refinitiv-related D&A, and certain FX items, and assuming an effective tax rate of 22%, we reported adjusted net income per diluted share of $0.45. Please see the earnings release and Form 10-Q to be filed with the SEC for additional information regarding the presentation of our historical results.\n\nNow, let me turn the call over to Lee.\n\nLee Olesky -- Chief Executive Officer\n\nThanks, Ashley. Good morning, everyone, and thank you for joining our third quarter earnings call. As I take part in my last Tradeweb earnings call, I sit back and reflect upon this start-up that I co-founded over 25 years ago with $10 million in capital. The core approach was simple.\n\nListen to our clients and build services, products, protocols, and functionalities that enhance their trading workflows. Over those 25 years, the talented Tradeweb employees have grown this institutional U.S. Treasury start-up into a global, multi-asset class, multi-client, and multi-protocol business. One of the crowning achievements was the 2019 IPO, followed by the tremendous growth the team has produced as a public company.\n\nIn fact, from 2004 through 2021, we have averaged 12.9% annual revenue growth. In the first three quarters of 2022, we generated revenues of $896 million, up 55% from the first three quarters of 2019 or an average growth of 16% per year despite the material FX headwinds we are currently facing in 2022. The lion's share of this growth has been organic as a result of relentless focus on innovation and collaboration that continues to be the north star of our company, as we help clients trade as efficiently as possible. This strategy sounds simple, yet success requires perseverance.\n\nOur team has dedicated the time and focus to link different liquidity pools and markets, to deliver holistic, global, multi-asset class solutions, something we call connecting the dots. This incessant focus on moving markets forward has allowed us to develop a diversified business model that allows the company to drive strong revenue growth even when facing a challenging macro environment in some of our products and client channels. I'm thrilled to pass the baton to my longtime friend and partner, Billy. I am excited to see him, Tom, Sara, Enrico Bruni, who is the head of Asia and Europe, Chris Bruner, who built our institutional U.S.\n\ncredit business, Justin Peterson, our chief technology officer, and the entire Tradeweb team as they continue to build upon our competitive advantage, our people, network and technology. I am excited to watch the team capitalize on the long-term growth runway ahead and most of our markets still trading over the phone. Turning to Slide 4, record third quarter revenues of $287 million were up 8.2% year-on-year on a reported basis. The underlying strength in the business was even better, stripping out the 490 bps of FX headwinds that have been the most severe since we went public, we generated strong revenue growth of 13.1% on a constant currency basis and another double-digit revenue growth quarter.\n\nThe revenue growth and the resulting scale translated into improved profitability relative to full-year 2021 as our year-to-date adjusted EBITDA margin increased by 83 basis points to 51%. Adjusted earnings per share saw healthy growth of 15% year-on-year. Turning to Slide 5, the diversity of our growth was on display once again this quarter, marked by double-digit constant currency growth across all of our asset classes. Rates and credit continued to lead the way, accounting for 40% and 27% of our revenue growth, respectively, while equities provided 22% of the growth, a high-water mark in terms of growth contribution.\n\nSpecifically, rates posted its best third quarter revenues ever, driven by our continued growth across global government bonds and swaps. In cash rates, U.S. Treasury revenues were up nearly 10% year-on-year given the acceleration of our retail business due to the higher rate environment. Swaps produced another strong quarter with positive market share growth, while mortgage revenues declined given the challenging rate backdrop.\n\nCredit posted another strong quarter, driven by strong Munis, U.S. corporate credit, and CDS trading. Equities posted its highest third quarter revenues ever driven by institutional ETFs and our efforts to diversify and grow our other equity products. Money markets set a new record fueled by growth in our retail CD franchise and continued organic growth in institutional repos.\n\nFinally, market data revenue growth was equally split across our Refinitiv contract and our proprietary data products, which continued to enjoy robust growth. Moving on to Slide 6 I will provide a brief update on two of our main focus areas U.S. Treasuries and ETFs and turn it over to Billy to dig deeper into U.S. credit and global interest rate swaps.\n\nStarting with U.S. Treasuries our market share fell slightly to 19.6% of the U.S. Treasury market. The slowdown that we saw in the second quarter within our institutional asset manager and hedge fund clients, as they moved to the sidelines and trimmed risk as volatility spiked, persisted into July.\n\nActivity started to improve exiting July with both August and September registering month-over-month increases. The leading indicators of the institutional business remain strong. We gained share versus Bloomberg and client engagement was good with the number of users increasing by 10% year-on-year and 3% quarter-on-quarter. On the other hand, our wholesale performance was mixed as our legacy streaming offering saw positive revenue growth while our CLOB underperformed as elevated volatility benefited the incumbent.\n\nRecall when we acquired NFI, the first phase of our integration plan was focused on expenses-consolidating broker-dealers and technology platforms and migrating the data center. We will be consolidating the broker-dealers shortly and plan to migrate data centers during the first half of 2023. After we migrate the data center, we expect that to be a catalyst for revenue growth as we rebuild the liquidity pool. On the whole, we believe the US Treasury business is in a unique position with deep retail, wholesale, and institutional liquidity pools giving us the ability to continue to grow and capitalize on any potential market structure change.\n\nFinally, within equities, institutional ETFs produced strong quarterly revenue growth with average daily volume up 43% year-on-year driven by new client wins and strong industry volumes. The client pipeline remains strong as the benefits of our electronic solutions continue to resonate. Structurally, we are seeing an increase in cross-asset trading, whereby ETF RFQs are being placed by both fixed-income and equity trading desks. Our other initiatives to expand beyond our flagship ETF franchise are also bearing fruit with momentum continuing in the equity options, convertibles, and ADRs.\n\nWe look forward to crossing the $100 million annual revenue mark in the coming quarters and we believe we remain well-positioned to benefit from the secular growth in ETFs and our other growth initiatives scaling. With that, I will turn it over to Billy.\n\nBilly Hult -- President\n\nThanks, Lee, and congratulations on a terrific run at Tradeweb. As Lee highlighted in his opening, we have methodically grown our asset class, geographic, and client footprint over the last 25 years. One thing that has been constant at Tradeweb is our singular focus on collaborating with our clients to drive change in the fixed-income markets. Despite all the success we've had to date, I believe the best is yet to come.\n\nIn fact, we just completed an offsite where we gathered our senior leaders and discussed our growth outlook for the next few years. The energy and optimism around the durability of our growth was remarkable-we expect credit and swaps to continue to be the backbone of our growth but will also be expanding our EM and muni footprint in a meaningful way. As you might expect, we are also working on a few more initiatives that we will reveal in due course. I am truly excited about the team that we have assembled and our ability to deepen our competitive advantage across our people, network, and technology.\n\nOn that note, I'd like to officially welcome Tom Pluta, who joined as president-elect at the beginning of the month, and I believe he will be a valuable addition as we look to grow Tradeweb's footprint over the coming years. Turning to Slide 7 for a closer look at credit. We quite often talk about the diversity of the business across asset classes, but the diversity within each asset class shines in moments like this. Corporate credit faced a mixed industry volume backdrop given the elevated volatility, continued fee per million pressures across institutional IG due to a reduction in duration, and tougher market share conditions across high yield.\n\nHowever, the elevated volatility and wider spreads continued to boost our CDS business, and the higher rates helped drive nearly 90% year-over-year revenue growth in our muni and retail and middle market credit businesses. The product of this was a healthy quarter with 12% year-over-year constant currency revenue growth. It's amazing to see our growing credit business now annualizing over $300 million in revenues, led by U.S. Credit.\n\nWe have a differentiated strategy in U.S. Credit, and we continue to work on building out that puzzle, expand our client network, grow our all-to-all volumes, and develop our integrated strategy across client channels. Electronically, credit is a young market with plenty of potential for further innovation and we believe that our holistic credit approach and strong feedback loop with clients will continue to help us expand our network. We are excited to hit new fully electronic market share records in IG and we believe further investments in high yield can lead to a similar outcome in the coming quarters and years.\n\nOur institutional volume growth continues to be underpinned by growth in RFQ and portfolio trading. Our third quarter RFQ average daily volume grew 14% year-over-year driven by investment grade. RFQ remains the main protocol in the U.S. Credit market, but we realized that the protocol hadn't evolved very much over the last 15 years.\n\nSo rather than imitate, we reimagined the RFQ protocol to create a differentiated client trading experience and we are excited about the initial positive results that we have achieved over the past few quarters. Expanding our RFQ presence across IG and high yields remains our biggest opportunity and we continue to see great success cross selling the innovations we have brought to the credit market to gain wallet share. Despite the continued increase in spreads and volatility, we also continue to see strong portfolio trading activity on the platform with average daily volume growing 13% year-on-year and September being another record month. The underlying trends remain impressive globally.\n\nThe number of users are up by 15% while the line items traded were up over 35% year-over-year. In the quarter, our largest trade was greater than $2 billion. Behavior change takes time, but clients are increasingly using our market-leading portfolio trading solution to access greater liquidity, minimize information leakage, improve certainty of execution, trade less liquid instruments more efficiently, trade credit portfolios at the close, and reduce workload and operational risk. The strength in RFQ and portfolio trading was matched by the strong growth of our anonymous liquidity solution, AllTrade, which saw nearly $100 billion in volume with average daily volume increasing 12% year-over-year.\n\nOur all-to-all liquidity volumes saw positive year-over-year growth across IG but faced tougher client conditions within high yield. While high yield volumes were down year-over-year, the number of high yield all-to-all responders increased by 12% year-over-year and is up 40% since the beginning of 2021 giving us confidence that we can continue to deepen our liquidity pool moving forward. Sessions volumes saw double-digit volume growth led by IG, while HY faced tougher hit rate conditions given more one-way submission flow. Finally, we remain laser-focused on maximizing the value of session liquidity uploaded on our platform through newer protocols like Rematch, which accesses our all-to-all liquidity.\n\nOur Rematch average daily volume was up nearly 80% in the third quarter. Turning to the non-US credit business, revenue grew 17% year-over-year and continued to perform well in the current market environment. Our muni business achieved record third quarter revenues, as the retail market sprung back to life and the institutional business, which grew more than 150% year-over-year, continues to attract new clients. We'll be leveraging our leading presence in the tax-exempt muni space to expand our institutional offering to include taxable Munis soon.\n\nOur recent rollout of our Ai-Price for Munis has gone well and we recently partnered with SIX Financial to redistribute our muni data. Another area of focus over the coming years is emerging market credit. Our current EM portfolio trading offering continues to scale, and we are methodically expanding our presence across all rates and credit products. We believe our position as a global multi-asset class firm gives us a unique one-stop shop proposition, being able to offer EM products across swaps, CDS, credit, and China bonds to our clients.\n\nThe continued volatility in the market boosted our CDS revenues which grew 45% year-over-year with strong growth across regions. Finally, we're excited about our collaboration with S&P Global Market Intelligence to introduce electronic connectivity between primary and secondary markets across European credit, covered, sovereign, supranational, and agency bonds. In sum, it was another solid quarter for credit, and we continue to see a lot of opportunity in credit as our institutional and wholesale platform continues to scale and the retail business continues to thrive. Moving on to swaps, the multi-year growth story continues as swaps registered another strong quarter aided by rebounding industry volumes and market share gains.\n\nOur variable swaps revenues grew 23% year-over-year, driven by strong growth across tenors and market share climbing to 15.2%. Since the beginning of 2019, the swaps industry has fluctuated from high growth to negative growth, high rates to zero rates, and now back to higher rates and fluctuating volatility. Over those 15 quarters, our swaps business has produced an average of 30% year-over-year revenue growth, a testament to the resiliency of our market-leading swaps business and the strong growth opportunity that we feel is underappreciated. Our momentum in major currencies continues with record year-to-date share in dollar, euro, pound, and EM-denominated swaps.\n\nWe believe the LIBOR transition is progressing well, 50% of our year-to-date volumes came from SOFR trades, up from 14% in the year-ago period with 95% of our dollar swap clients having executed a SOFR-based trade since the start of the year. Inflation and the upward pressure on commodity prices have shown little sign of abating. Central banks continue to raise interest rates to help counter rising inflation. However, such uncertainty means market participants have had to make longer-term decisions about how they hedge their exposure to inflation.\n\nSince executing our first cleared inflation swap transaction in 2017, Tradeweb has carved out a leading position in the electronic execution of inflation swaps, just another example of us helping our clients improve their execution experience. Year-to-date, inflation swaps volumes are up over 60% year-over-year. Beyond the risk-free rate transition and inflation swaps, we continue to respond to structural changes in the swaps market, making strong advances in cleared EM swaps and request for market protocol adoption. We saw record EM share in the first nine months of the year with revenue increasing by over 100% year-over-year.\n\nWe believe if we increase our market share by an incremental 10% of the cleared EM market, that could add up to an additional $15 million in variable revenues assuming current market average daily volumes. The long-term opportunity is even larger. Since 2017, Clarus EM IRS average daily volumes have increased at an average of 24% per year. Finally, we also saw record RFM activity as we continue to onboard dealers and deepen our liquidity pool globally.\n\nLooking ahead, we believe that the long-term swaps revenue growth potential is meaningful. With the market still only 30% electronified, we believe there remains a lot that we can do to help digitize our clients' manual workflows while the global fixed-income markets and broader swaps market grow. And with that, let me turn it over to Sara to discuss our financials in more detail.\n\nSara Furber -- Chief Financial Officer\n\nThanks, Billy, and good morning. As I go through the numbers, all comparisons will be to the prior year period, unless otherwise noted. Let me begin with an overview of our volumes on Slide 9. We reported record third quarter average daily volume of nearly $1.1 trillion, up 14% year-over-year, and up 12% when excluding short-tenor swaps.\n\nAmong the 22 product categories that we include in our monthly activity report, 10 of the 22 product areas produced year-over-year volume growth of more than 20%. Areas of strong growth include European government bonds, global swaps, U.S. investment grade credit, Munis, credit swaps, and global ETFs. Slide 10 provides a summary of our quarterly earnings performance.\n\nThe third quarter volume growth translated into gross revenues increasing by 13.1% on a constant currency basis, continuing our track record of double-digit revenue growth. FX headwinds of 490 basis points led to reported growth of 8.2%. We derived approximately 36% of our revenue from international customers and recall that approximately 30% of our revenue base is denominated in currencies other than dollars, predominantly in Euros. Our variable revenues increased by 14.8% and our total trading revenue increased by 8.6%.\n\nTotal fixed revenues related to our four major asset classes were down 5.1% but were flat on a constant currency basis. Rates fixed revenues were down given the migration of certain European government bond clients from fixed to variable contracts at the end of last year and the impact of FX. Money markets fixed revenue growth was driven by global repos. Other trading revenues were down 2%.\n\nAs a reminder, this line does fluctuate as it is affected by periodic revenues tied to technology enhancements performed for our retail clients. Market data increased by 3.4% due to growth in Refinitiv and our proprietary data products. This quarter's adjusted EBITDA margin of 51% increased by 86 basis points on a reported basis and 130 basis points on a constant currency basis relative to the third quarter of 2021. Similarly, our adjusted EBITDA margin for the first nine months of 2022 increased by 83 basis points on a reported basis, and 109 basis points on a constant currency basis from the full year 2021.\n\nWe remain committed and on track to deliver annual margin expansion in 2022 and there has been no change to our philosophy of balancing revenue growth with margin expansion. All in, we reported adjusted net income per diluted share of $0.45. On slide 11, we contextualize the impact of FX on our historical results. The key takeaway here is the extreme moves in FX this year are unprecedented and are masking the strength and consistency of our constant currency revenue growth.\n\nSpecifically, the third quarter FX headwinds of nearly 500 basis points were driven by a 14% decline in the Euro relative to the U.S. dollar, which is the highest decline we have seen year-to-date and remains in October. That said, when you compare our constant currency growth rates versus prior years, you can see the continued momentum across our business. This is a testament to the diversity of our business model across asset classes, protocols, geographies, and client channels.\n\nThis diversity allows us to uniquely navigate different macro environments while the secular story of electronification unfolds. As Billy highlighted, we are excited about the growth potential that lies in front of us and we believe we have multiple significant initiatives that will help us to continue to drive double-digit revenue growth over the long term. On top of our own initiatives, as yields increase across fixed income, we expect the interest from clients investing and trading in fixed-income products to continue to increase. Moving on to fees per million on Slide 12.\n\nThe trends I am about to describe are driven by a mix of the various products within our four asset classes. In sum, our blended fees per million increased 1% year-over-year, primarily as a result of stronger growth in higher fee-per-million rates derivatives and cash equities. Excluding lower fee per million short tenor swaps and futures, our blended fees per million were up 3%. Let's review the underlying trends by asset class, starting with rates Average fees per million for rates were up 4%.\n\nFor cash rates products, fees per million were up 14%, primarily due to a positive mix shift toward higher fee per million U.S. Treasuries and the migration of certain European government bond clients from fixed to variable contracts at the end of last year. For long-tenor swaps, fees per million were down 7%, primarily due to lower duration while we continue to see growth in EM swaps and RFM. In other rates derivatives, which includes rates futures and short tenor swaps, average fees per million increased 34% due to a shift toward rates futures, which carries a higher fee per million than the group average, and a core increase in OIS fee per million.\n\nContinuing to credit, despite the higher fee per million across cash credit, credit derivatives, and electronically processed U.S. cash credit, average fees per million for credit decreased 17% due to relative product mix with stronger volume growth in lower fee per million credit derivatives and electronically processed trades. Drilling down on cash credit, average fees per million increased 4% despite the continued U.S. high-grade fee pressures, due to stronger growth in U.S high-grade and Munis, which both carry a higher fee per million than overall cash credit.\n\nNotably, our fully electronic U.S. high-grade volumes were a record in the third quarter. Looking at the Credit Derivatives and electronically processed U.S. Cash Credit category, fees per million increased 3%, driven by stronger growth in European index CDS, which carries a higher fee per million than the group average.\n\nContinuing with equities, average fees per million for equities were up 23%. For cash equities, average fees per million increased by 20% due to an increase in fees per million within U.S. ETFs which was driven by a decrease in notional per share traded. Recall in the U.S.\n\nwe charge per share and not for notional value traded. Equity derivatives average fees per million increased 1% due to an increase in convertibles fees per million. Finally, within money markets fees per million increased 2%. This was primarily driven by a mix shift toward U.S.\n\nCDs, which offset a decrease in our U.S. repo fees per million. In addition, the higher fee per million retail money markets business continues to improve given the higher interest rate environment. Slide 13 details our expenses.\n\nAdjusted expenses for the third quarter increased 6.8% and 10.4% on a constant currency basis. Recall that approximately 15% of our expense base is denominated in currencies other than dollars, predominantly in Sterling. The third quarter of 2022 adjusted operating expenses were higher as compared to the third quarter of 2021 primarily due to increased employee compensation, technology and communication and G&A. Compensation costs increased 4.6% due to higher headcount.\n\nAdjusted non-comp expense increased 11.1% primarily due to technology and communications, G&A, D&A, and professional services but were helped by favorable movements in FX. Adjusted non-comp expense on a constant currency basis increased 16.1%. Specifically, technology and communication costs increased primarily due to higher clearing and data fees as a result of higher credit all trade volumes and streaming U.S. Treasury volumes which continue to grow.\n\nIn addition, this quarter also saw the continued impact of our previously communicated investments in data strategy and infrastructure. Adjusted general and administrative costs increased primarily due to an increase in travel and entertainment as we recover from the pandemic. Favorable movements in FX resulted in a $2.2 million gain in the third quarter of 2022 versus a $900,000 gain in the third quarter of 2021. Professional fees increased 6.4% mainly due to higher legal costs.\n\nSlide 14 details capital management and our guidance. First, on our cash position and capital return policy. We ended the third quarter in a strong position, holding $1.1 billion in cash and cash equivalents and free cash flow reached $555 million for the trailing twelve months. We have access to a $500 million revolver that remains undrawn as of quarter-end.\n\nCapex and capitalized software development for the quarter was $12.3 million, an increase of 23% year-over-year. We continue to expect capital expenditures and capitalized software to be in the range of $62 million to $68 million for the full year. With this quarter's earnings, the board declared a quarterly dividend of $0.08 per Class A and Class B share. We spent $11.3 million offsetting equity dilution during the quarter.\n\nSpecifically, we spent $9.0 million under our regular share buyback program, leaving $9.0 million for future deployment as of the end of the quarter. In addition, we withheld $2.3 million in shares to cover payroll tax obligations related to equity compensation. In October, we exhausted our $150 million share repurchase authorization, which expires at year-end. Given our historical philosophy of using share repurchases to offset the impact of our annual equity grants, we will be discussing with our Board renewing our buyback program, as well as other typical aspects and strategies within our capital management framework.\n\nTurning to other guidance items for 2022, we are now tightening our adjusted expenses to range from $620 million to $640 million, which incorporates the benefits from FX movements, mainly related to the Sterling. For forecasting purposes, we continue to use an assumed non-GAAP tax rate of 22% for the year. Finally, on slide 15, we have updated our quarterly share count sensitivity for the fourth quarter of 2022 to help you calibrate your models for fluctuations in our share price. Now I'll turn it back to Billy and Lee for concluding remarks.\n\nBilly Hult -- President\n\nThanks, Sara. Following the positive third quarter results, we believe we are on track for another great year at Tradeweb and for our 23rd consecutive year of record revenues. That level of consistent absolute revenue growth speaks to the resilience of our business model, and the team remains laser-focused on the things in our control, maximizing the power of our network to drive further innovation into the marketplace. While the ongoing FX environment act as headwinds to the core growth and earnings power of the business, we believe our competitive position has never been stronger, a testament to the impressive talent and network we have at Tradeweb.\n\nWith a couple of important month-end trading days left in October which tend to be our strongest revenue days, we are seeing double-digit volume growth across credit, equities, and money markets relative to October 2021. The diversity of our growth remains a theme as we continue to see double-digit average daily volume growth across U.S. high-grade credit, Munis, CDS, global ETFs, equity derivatives, repos, and retail certificates of deposit. We are seeing record average daily volumes in our muni business.\n\nOur IG share is in line with third quarter levels while high yield share is stronger than September levels.\n\nLee Olesky -- Chief Executive Officer\n\nI would like to conclude my remarks by thanking our clients for their business and partnership in the quarter and I want to thank my colleagues for their efforts that contributed to the record quarterly revenues and volumes at Tradeweb. As I sign off for my last earnings call, I want to also thank all the investors and sell-side analysts that I have had the great pleasure to meet over the last few years. With that, I will turn it back to Ashley for your questions.\n\nAshley Serrao -- Head of Treasury and Investor Relations\n\nThanks, Lee. As a reminder, please limit yourself to one question only. Feel free to hop back in the queue and ask additional questions at the end. Q&A will end at 10:30 am Eastern time.\n\nOperator, you can now take our first question.\n\nOperator\n\nThank you. [Operator instructions]. Our first question comes from the line of Richard Repetto from Piper Sandler. Your line is open.\n\nRich Repetto -- Piper Sandler -- Analyst\n\nYes, good morning, Lee -- and good morning, Lee, Billy, and Sara. First, Lee, I just want to congratulate you. You had a great run. You've been resilient and unflappable.\n\nI think I've used that word to describe you before. But well-deserved great run. My question is, what are you going to do now? Now my question is actually for Billy and you as well. But as you go through the transition, what will be your focus, Billy and what things you -- are you taken from Lee to -- as really the mantra to lead Tradeweb going forward?\n\nBilly Hult -- President\n\nIt's great question, Rich. Thank you for asking. Lee has obviously been great through this transition. I'm looking forward to working with him as chairman of the board.\n\nI would probably be a little bit more emotional and flowery in terms of what I was saying if like every analyst in the community plus all of these people weren't dialed in at this exact moment, so I'll leave that sentiment between Lee and I behind the closed doors. The groundwork has already obviously begun, and we're kind of hitting the ground running. We had -- and I referenced this in my prepared remarks, Rich, we had an excellent, excellent management offsite meeting at the end of the summer. When you have real engagement, you feel it and I think the team is, obviously, very charged up for the opportunities that lie ahead for the company.\n\nMy areas of focus, I think, obviously, you would understand exceptionally well. It's going to be talent development both myself and Lee have always kind of historically talked about the power and the importance of the people. So we're going to make sure that talent development stays first and foremost as a priority. Installing an executive leadership team, from my perspective, deepening our network with partnerships and acquisitions, these are major priorities.\n\nIt is, obviously, from my perspective, a great moment to have Tom Pluta on board. He'll be president of the company as of January 1. Both Lee and I have a long history and relationship with Tom. He's going to be an excellent addition to the management team.\n\nIt's always sort of awkward saying nice things about people while they are kind of looking across for me. Sara has been absolutely strong partner and an amazing CFO. So I feel personally really good about kind of where we are at this moment in time. To your great question about like what I'm going to kind of take from Lee, as much as I can.\n\nAt the end of the day, obviously, we're all kind of different people and different personalities. So I am going to be myself as the next CEO of the company in a way that I think will make Lee proud and the company proud and we're going to move on into this next chapter and succeed and do our best. But I appreciate your question, Rich. I think one thing for us to sort of determine is how I am going to still participate in your infamous kind of president's panel.\n\nMaybe Tom and I can kind of arm wrestle and figure out who is going to be the one that participates in that because I know that's like a big kind of historic ratings hit, but we appreciate your question always, Rich. So thank you.\n\nRich Repetto -- Piper Sandler -- Analyst\n\nI think you move up a slide, Billy, but anyway, Lee, great run, and congrats. Thank you.\n\nLee Olesky -- Chief Executive Officer\n\nThanks, Rich. I am just going to say something really quickly, and that is I think the company is in such good hands. I think the investors have a lot to look forward to. This is under Billy's leadership with Tom joining and Sara being here and the rest of the team, it's incredibly well positioned.\n\nAnd aside from the sort of opportunity of a company, the people who are in place are the same people who have been running this business for decades. Tom is new, Sara is relatively new, but I think we are so well positioned and I'm excited to watch them excel and grow the business and grow as leaders. Thanks for the kind remarks.\n\nRich Repetto -- Piper Sandler -- Analyst\n\nThank you.\n\nOperator\n\nThank you. One moment for our next question. Our next question comes from the line of Kyle Voigt from KBW. Your line is open.\n\nKyle Voigt -- Keefe, Bruyette and Woods -- Analyst\n\nHi, good morning. Maybe a question for Billy. There has been a sizable buy-side market participant in the U.S. treasury market that's been pretty vocal about wanting all-to-all solutions for the market.\n\nCan you just talk about the concept of all-to-all in U.S. treasuries? And how you see the market structure potentially changing over time from what is still a relatively bifurcated market structure today?\n\nBilly Hult -- President\n\nYes, sure. Great question, Kyle. How are you? So first thing you just ask like maybe like a quick, it's a good question, just like as a quick kind of point of kind of context to make a sort of strong point and kind of an important one. Obviously, the U.S.\n\ntreasury market is different than the credit market. It significantly start with, it's significantly more electronic. We have the estimates of the government bond market at around 60% versus kind of credit, which is around 45%. But I would say, more importantly, 80% of the activity in government bonds happens in like seven of the most actively traded issues versus credit, which you know well, Kyle, has, I think, like something like 13,000 CUSIPs, right? So there is a significant difference between those two businesses.\n\nThat being said, I think you've kind of nailed it in your question. First of all, the PIMCO kind of white paper that they wrote, I think, was like significantly important. PIMCO is a very influential, very important customer. It was a very thoughtful and very well-written white paper on some liquidity challenges in the government bond market.\n\nAnd so, we're going to be in a way that you would expect like exceptionally responsive. So I think we have a team literally at PIMCO kind of as we speak. We're going to engage with them directly, get their perspective on things. If we were going to kind of chart out some of our views on the evolution of it all, I think there is absolutely an aspect of all-to-all trading that makes sense in the sort of deeper areas of the off-the-run marketplace.\n\nWe can also kind of imagine a world, I think pretty easily where more and more of the buy side has access to what we describe as the central limit order book world, which is why it's been very important for us from a strategic perspective to be in that business. So we feel like we are kind of really well set up around this evolution and there is an interesting kind of back-and-forth debate on this, and I think, ultimately, at the end of the day, as we move forward around this, it's important to remember that there is not necessarily at all one trading protocol that fits one marketplace. So we do feel like there is a role potentially for all-to-all trading and government bonds, just like there's obviously always going to be a significant and sizable role around RFQ trading, request for market trading, disclosed stream trading. There are a bunch of very important protocols in the government bond market that will make this a continued vibrant and important marketplace.\n\nBut this is a topic that fits us like a glove and we're going to play a leadership role around it, I think, in a way that you would expect us to. So thanks very much for the question.\n\nKyle Voigt -- Keefe, Bruyette and Woods -- Analyst\n\nNo. Thank you.\n\nOperator\n\nOne moment for our next question. Our next question comes from the line of Craig Siegenthaler from Bank of America. Your line is open.\n\nCraig Siegenthaler -- Bank of America Merrill Lynch -- Analyst\n\nHey, good morning, everyone. And I don't know if you guys heard, but it's Craig Siegenthaler from Bank of America, it cut out on me.\n\nSara Furber -- Chief Financial Officer\n\nHi, Craig.\n\nBilly Hult -- President\n\nHey, Craig.\n\nCraig Siegenthaler -- Bank of America Merrill Lynch -- Analyst\n\nSo my question is on portfolio trading. What were the major drivers of the sequential decline in international portfolio trading other than FX? And also, can you just put this in a context of the longer-term growth trajectory of portfolio trading adoption outside of the U.S.?\n\nBilly Hult -- President\n\nYes, I mean, I think we're fully trading is going to fit really well into that European community in credit. They tend to be very focused on I think, two of the most important kind of principles around portfolio trading, which is, from our perspective, information leakage and certainty of execution, and the feeling that we have is that it's going to become more and more of a risk transfer trading tool for those European customers. There is going to be kind of ebbs and flows on a month-to-month basis around some of these market share numbers. General feeling, obviously, is that portfolio trading works better and right now has more what we would describe as sort of straightforward acceptance in high grade than sort of the less liquid areas of the credit market, but this is a fundamentally important protocol in the credit markets globally.\n\nAnd we feel like the European community is generally very supportive of what we're building and where we're arriving with our portfolio trading. And thanks very much for the question.\n\nSara Furber -- Chief Financial Officer\n\nCraig, I'd just add that, obviously, as you alluded to, FX does play a role in terms of that comparison, whether you're looking at the year-over-year period, third quarter for third quarter, or nine months FX, particularly the Euro is down quite a bit.\n\nCraig Siegenthaler -- Bank of America Merrill Lynch -- Analyst\n\nThank you.\n\nOperator\n\nAnd one moment for our next question. Our next question comes from the line of Michael Cyprys from Morgan Stanley. Your line is open.\n\nMichael Cyprys -- Morgan Stanley -- Analyst\n\nGreat. Thanks. Good morning. Hey, just curious your perspectives on the SEC's recent proposal for the central clearing of treasuries.\n\nWhat sort of potential impacts could we see in the marketplace? What sort of opportunity do you see in this for Tradeweb how you might sort of quantify that? And what sort of actions might you need to take to best capture the opportunity?\n\nBilly Hult -- President\n\nYes, a great question. It's interesting. I mentioned the PIMCO white paper, and I do think it resonated really strongly within the community. It's interesting.\n\nThey are not a proponent really of central clearing. So, I mentioned that because you do really get a sort of like interesting kind of debate back and forth around the benefits. Our general perspective is it's good for our business. In a straightforward way, it reduces our capital requirements and we have learned a bunch of lessons around how central clearing was applied to the global swaps market and how that accelerated the electronification of that market from really sort of a little bit of a negotiated back-alley market into this really strong electronified market that exists today.\n\nSo we are proponents of it. What we would say is, as the first question I got around government bonds was really about the liquidity of the market. We want to be exceptionally thoughtful that by embracing central clearing, we are not affecting the liquidity of the government bond markets where there can be a perspective that certain players who are important in the market today would find an expense level too high to be as active participants in a market going forward. So, we want to be thoughtful about how this winds up getting applied.\n\nWe are going to be kind of heard on this issue, I think, in a way that you would expect us to be heard. We have a lot of credibility, obviously, as the leading electronic venue in government bonds. So we're going to come out with our own, I think, strong view. But it's going to take into effect a lot of the nuances that I was kind of mentioning before.\n\nBut general feeling is like it's good for us and we're set up well for it. I think the debate on this will continue for a little while. And thanks for the question.\n\nMichael Cyprys -- Morgan Stanley -- Analyst\n\nThank you.\n\nOperator\n\nOne moment for our next question. Our next question comes from the line of Andrew Bond from Rosenblatt Securities. Your line is open.\n\nAndrew Bond -- Rosenblatt Securities -- Analyst\n\nHey, good morning. Following up on that portfolio trading, September was a record month for portfolio trading at Tradeweb despite some concerns at higher levels of volatility to limit growth and more volume would shift to all-to-all protocols. Do you think portfolio trading continued to grow meaningfully if markets remain highly volatile or is there a limit to some of the growth in this environment?\n\nBilly Hult -- President\n\nNo, it's going to keep growing, right? It's getting more applied, for sure, into the IG world, into the investment-grade world than high yield, which still has, I think, some of the history and some of the behavior habits around the all-to-all kind of trading style. But I think the one thing that we have, I think, decided in a pretty strong way, is that the all-to-all environment is not necessarily the most conducive environment for real kind of risk transfer trades and so one of the things I think that makes us really strongly positive on the value of portfolio trading is the way that portfolio trading has from our perspective, become a real risk transfer mechanic or mechanism around that and that's important. So we feel like it behaves really well in volatile markets. Right now, it's kind of being applied more to IG than high yield.\n\nSome of that is behavior. As you know, the behavior change kind of takes time and I think some of the behavior around high yield still goes into that all-to-all environment, if that makes sense, and thanks for the question.\n\nAndrew Bond -- Rosenblatt Securities -- Analyst\n\nThank you.\n\nOperator\n\nThank you. One moment for our next question. Our next question comes from the line of Alex Blostein from Goldman Sachs. Your line is open.\n\nAlex Blostein -- Goldman Sachs -- Analyst\n\nHey, good morning, guys. Thanks for taking the question. Billy, I wanted to spend a couple of minutes maybe on some of the competitive dynamics in credit trading and really just kind of maybe you zoning in on some of the convergence we are seeing between different protocols that you and MarketAxess are starting to zone in on. So on the one hand, you guys have been leading in portfolio trading.\n\nMarketAxess is now doing more portfolio trading as you guys are pushing more aggressively into RFQ with some of the innovation you mentioned as well as all-to-all. So, as these two kinds of Venn diagrams start to converge, what are your views on pricing? Is it reasonable to think we'll start to see more pricing pressure in the space or really more competitive dynamics on pricing, I guess? And then, just a reminder, how do you guys compare to the incumbent in the space in terms of apples-to-apples kind of comparison on pricing. Whether or not you guys will be able willing to kind of lean into that a little bit more?\n\nBilly Hult -- President\n\nIt's a great question, Alex, and thanks very much. I kind of have made this point before pretty strongly that as we have entered into the credit space and shown our ability to really compete in the credit space at a very high level, we've never kind of led with price. I think that's an important thing. We've led with innovations and creating efficiencies for our clients, and we feel at a very -- in a very strong way that the market is really supportive and wants kind of this competition in a way that you just described because they benefited from it.\n\nAnd I've always been, I think you know in a very straightforward way, like a complementary of MarketAxess from the perspective of having gotten a lot of things right. I think they were a little bit late around portfolio trading and have done a very good job recently of understanding how important that protocol is and doing better in it. One of the things for sure that we found is, as we delivered innovations to our customers, specifically speaking, around portfolio trading or around net spotting and net hedging, we are able to get more of their kind of traditional RFQ business as a consequence. So in the exact way that you described, I do think there is some convergence of where we are all competing.\n\nThat being said, again, high level and in a really important way, the market really does want to support and have this kind of competition in the space. As you know exceptionally well, we grew up competing in a lot of the markets that we are in, Alex, with Bloomberg from essentially day one. So that competitive dynamic has kind of existed for us always and I think it makes both firms better and I think the clients wind up winning as we continue to innovate. I don't know, Sara, if you have -- if you want to add any comment around kind of pricing?\n\nSara Furber -- Chief Financial Officer\n\nYes, I would say, look, we were a newer entrant into the credit space. I think generally, it's hard to be apples-to-apples, but generally apples-to-apples but I think our pricing is a little bit lower. But as Billy said, I think the more important point is we compete through innovation, and we compete differently. Our business mix in terms of different client channels is also a differentiator between retail, institutional and wholesale.\n\nBilly Hult -- President\n\nThanks for the question, Alex. Good to hear your voice.\n\nOperator\n\nThank you. One moment for our next question. Our next question comes from the line of Daniel Fannon from Jefferies. Your line is open.\n\nDan Fannon -- Jefferies -- Analyst\n\nThanks. Good morning. I had a question on high yields and just kind of the market share dynamics more recently. Is this -- can you describe it more to some of the volatility? Just trying to think about the longer-term trajectory of -- as you think about market share, is there something structurally different about this market and your ability to kind of grow share over time versus say, high grade and talk a little bit more specifically about some of the near-term dynamics?\n\nBilly Hult -- President\n\nI think it's a combination really of, sort of volatility in the market. It's a good question. I think it's a combination of sort of volatility in the market at a moment in time, plus the reality that high yield tends to be, ultimately, less liquid that tends to have strong behavior in that marketplace around all-to-all trading. And our network has come a long way from when we were first answering these questions from you guys, thoughtful questions from you guys back in March of 2020 around our high-yield responder network.\n\nBut at the end of the day, MarketAxess still has the sort of default liquidity in that high-yield network and as that market kind of stays all to all a little bit, they wind up winning. That being said, we had an excellent month so far in our market share around portfolio trading, specifically speaking, in high yield. So these things kind of have their own life form and can kind of turn pretty quickly. We are really strong on selling the benefits of portfolio trading to our clients around maintaining their relationship with the market makers, the benefits around cost, the benefits around information leakage, minimizing information leakage, and the benefit around executable trading on one level.\n\nSo we feel really good that that message continues to resonate. And at the end of the day, that's kind of what we care about. So I think we're well positioned there.\n\nOperator\n\nThank you. One moment for the next question. Our next question comes from the line of Gautam Sawant from Credit Suisse. Your line is open.\n\nGautam Sawant -- Credit Suisse -- Analyst\n\nHey, good morning, and thank you for taking my question. Can you please share your perspective on the impact that rise of fixed-income ETFs is having on industry market structure and fixed-income turnover velocity? And also, can you touch upon your future growth initiatives within the ETF marketplace and how the Tradeweb platform is positioned relative to competitors?\n\nBilly Hult -- President\n\nI mean, I think in the most straightforward way, right, we have an exceptionally strong ETF business both in the U.S. and Europe. So we have this great global ETF business that has had exceptional success throughout this year and specifically speaking over the last quarter. One of the things I think that's really important is that the traditional ETF market makers are playing a larger and larger role around market making in credit.\n\nWe do feel like that has given us a little bit of an advantage as we've continued to kind of march forward in our credit offering as the significant kind of ETF players also become stand-alone important market makers in credit. So that kind of helps kind of round out or kind of put the pieces of the puzzle together for us around ETFs and credit. Our perspective is, this ETF business is going to continue to grow. It's obviously benefited in a very strong way from the volatility in the equity markets and we have a really strong team globally around our ETF business.\n\nSo I feel really good about how we are positioned in ETFs and also feel really good about how that has given us an edge in terms of how we built out our credit business as well. And thank you -- thanks a lot for the question.\n\nOperator\n\nOne moment for our next question. Our next question comes from the line of Alex Kramm from UBS. Your line is open.\n\nAlex Kramm -- UBS -- Analyst\n\nYes. Hey, good morning, everyone. Not to be too overly focused on the monthly minutia, but when you gave your update for October, I know with a couple of days left, the one business that was noticeably absent, which is the biggest business is interest rate swaps. So just trying to get a feel what's happening there? I mean if you look at some of the data that we track intra-month, it looks like that business is actually down year-over-year.\n\nSome of this may be FX. But after seeing a nice trajectory during the third quarter, we are kind of hoping 4Q could kind of reaccelerate here. And just wondering if anything is weighing on this and what needs to change for that business to kind of accelerate to historical growth rates again. Thanks.\n\nBilly Hult -- President\n\nHey, Alex, it's Billy. You are allowed to get into the minutia in any way that you want. So we really appreciate the question. Like the European swap story for us has been like a significant, significant success, right? It's been really kind of the lead horse for us in our entire rates complex.\n\nTo your exact and specific question, it's taking -- the European swaps market is taking a little breather in these few weeks in October. So the volumes are down a little bit. I think it's been through, obviously, a significant amount of volatility and some of the players who have been actively involved throughout this year are taking a little bit of a half a step back. Big picture, we feel exceptionally strong about how we're positioned in that business.\n\nWe have built out really important protocols around request for market, which have landed squarely with our most important hedge fund clients in Europe. There is going to be a continued sort of onboardment of clients into the MiFID world in Europe and so we feel really strongly that we're positioned very well around our European swaps business going forward. So you are correctly identifying something, but I wouldn't read too much into it, Alex, but completely appreciate your question and your attention to detail. Thank you.\n\nOperator\n\nSir, will you be taking more questions at this time?\n\nAshley Serrao -- Head of Treasury and Investor Relations\n\nYes, we'll take two more.\n\nOperator\n\nOne moment for our next question. Our next question comes from the line of Ken Worthington from J.P. Morgan. Your line is open.\n\nKen Worthington -- JPMorgan Chase and Company -- Analyst\n\nHi, thanks for squeezing me in. We talked a lot about innovation, and I think Lee kicked off with listen to your clients, build products, connect the dots. What happens to innovation at Tradeweb in more challenging or more extreme environments like we've seen in recent months and quarters? Do you get more actual ideas and more opportunities to execute? Is this really the time when innovation takes off or is it the opposite and things start to stall because you're too busy? And then you highlighted swaps and credit as the backbone for growth and EM and Munis is having a lot of opportunities, where does new innovation really need to be for you to deliver on these growth opportunities?\n\nBilly Hult -- President\n\nSo, good question, Ken. You -- in a very sort of reasonable way, in a way that you are describing, you have to be sort of aware of the environment. So I am going to say that in a very clear way. You have to have kind of good court awareness.\n\nSo when to make an obvious point, when the long bond is up a point or two points, you have to be a little bit careful around your 3:30 meeting that is scheduled, right? We thrive on this kind of sort of one-on-one meetings and the sort of like approach around the white paper and let's idea generate and let's solve things. So you have to be aware. To your question around the moment in time in the marketplace, and I think we're really good at that. We're really good at understanding what our clients are going through and what their lives, what their business lives are like.\n\nThat being said, in a really interesting way to your question, I think the stakes get really high around the innovations, right? So a tweak here or a tweak there around how portfolio trading works or a tweak around the response time around request for markets that I talked about around European swaps. These have like real market and real-life consequences at a point in time where the markets are extremely volatile and challenging. So I think the stakes get higher. I think our credibility of kind of having been that partner around innovation, I think, matters more when the markets get more challenging.\n\nOur pipeline is as strong as ever. The idea generation kind of continues. But you are right, you have to be kind of aware that there are moments where a Friday morning is free and then all of a sudden, it's not free. So you have to pick and choose your spots when you are dealing with and talking with high-level market professionals, the team is really good at that and really good at understanding that.\n\nSo that's how I would kind of understand -- that's how I would describe that point to you.\n\nSara Furber -- Chief Financial Officer\n\nAnd I'd just chime in, I think kind as a complement to that mindset which is, we have a really strong track record of continuing to make investments in all market conditions and so you mentioned EM and Munis. And I think it's not a need to invest in those initiatives. That's just our core philosophy on innovation and growth and so we've been able to do that. This year is a really good example.\n\nWe've been able to invest in these new areas, in our technology and our data and infrastructure while also delivering margin improvement. And so part of the beauty of the operating model is that strategy of constantly being close to your clients to innovate in the near term around acute volatility, in the long term around having fundamental growth drivers is something that we had a really good strong track record of.\n\nKen Worthington -- JPMorgan Chase and Company -- Analyst\n\nThank you.\n\nBilly Hult -- President\n\nThanks for the question, Ken.\n\nOperator\n\nOne moment for our next question. Our next question comes from the line of Chris Allen from Citi. Your line is open.\n\nChris Allen -- Citi -- Analyst\n\nGood morning, everyone, and thanks for taking my question. Maybe just following up on Sara's comments around delivering margin improvement, can you maybe talk about your ability to manage expenses and provide some details on some of the puts and takes with FX, travel entertainment, inflation, and variable comp moving forward?\n\nSara Furber -- Chief Financial Officer\n\nSure. Thanks. It's a great question. I think at the highest level, I think a really helpful way to think about it is sort of a rule of thumb.\n\nAbout 50% of our overall expense base is either variable or discretionary. But the highest level we have a real amount of flexibility in terms of how we manage our expenses through various market conditions and be able to still deliver margin expansion. Obviously, we've talked about a very consistent philosophy of balancing that margin expansion with driving and investing in long-term revenue growth. You asked specifically, which is like a more near-term question around puts and takes and where we're managing inflation.\n\nI think this year is a really good sample set. Inflation for us really comes down to people costs. The vast majority of our expense base is people, and we feel like we've done a really effective job in managing those trends, while still investing in hiring and being able to compete really effectively for talent while still delivering on the margin and we expect to continue to do that. The last piece is FX, which is obviously not completely in our control as it was FX has been a headwind.\n\nThis quarter is somewhat unprecedented, and we put in the earnings, and I think it's at Page 11 to break it out a little bit in terms of how FX moves on the revenue line. On the expense line, roughly, the rule of thumb there is about 15% of that expense base is correlated to sterling. Sterling, if you looked at this quarter is down 14% versus the dollar. So that has a positive impact on the quarter.\n\nOverall, in that same time period, euro is much more of a correlation on revenues, that's a 30% correlation and that's also been a drag. And so net, net FX has diluted to our EBITDA margin. We do have a hedging strategy that dilutes that impact and that volatility quite a bit on the cash flow. But FX certainly has offset and sort of dampened the expense growth from a reported basis.\n\nBut overall, as we view with, I think, the comments that we've made, we like our flexibility. We like our ability to make consistent and continuous investments to overall make sure that we're making smart decisions that help support that double-digit revenue growth opportunity over the long term. It won't be linear, but I think that consistent philosophy has really served us well.\n\nOperator\n\nThank you. One moment for our last question. Our last question comes from the line of Brian Bedell from Deutsche Bank. Your line is open.\n\nBrian Bedell -- Deutsche Bank -- Analyst\n\nGreat. Thanks so much for squeezing me in. I appreciate it. A question for Billy.\n\nMaybe talk about the interest rate swap market. I mean, that and credit obviously, you've identified as the two biggest growth areas, but you did say the interest rate swap market for Tradeweb is an underappreciated growth story. So maybe just the credit business obviously gets all the hype given we can see your direct competitor there. Maybe talk about what you see between those two businesses as sort of the better, say five-year growth opportunity for Tradeweb in particular and why that would be the case for NIM?\n\nBilly Hult -- President\n\nYes. I mean it's an interesting story around interest rate swaps and it's a great question, right? The interest rate swap market historically was sort of the most resistant toward the electronification of markets of kind of any of the markets that we ever got into, and not to bring Lee down memory lane as the call is ending, but he remembers that the best. So, part of our success there came with a lot of hard work around behavior change. The other part of our success there came really around playing a leadership role around regulation as that market, obviously, went electronic around Dodd-Frank in the U.S.\n\nand then kind of MiFID in Europe. I would argue the combination of the dollar swap market and the European swap market are two of the most important markets in the world in terms of everything that's been happening in the rates complex over the past six months. We feel exceptionally good around how we're positioned kind of competitively in that space and we also feel exceptionally good around the kind of wallet that's historically been attached to that space. And we love the fact that our clients are getting more sophisticated using our products like AiEX more frequently and we kind of click I think, really, really well in that marketplace.\n\nObviously, considering we've had this leadership role in global government bonds, TBA mortgages for a long time. So it fits us like a glove and our general feeling is this marketplace is going to continue to be exceptionally important going forward and we are going to have that leadership role. And that's some of the kind of foundation about why we feel very confident there. And thanks a lot for the question, Brian.\n\nOperator\n\nNow I turn the call over to Lee Olesky for any closing remarks.\n\nLee Olesky -- Chief Executive Officer\n\nOK. Yes. Thank you. Let me just say quickly, I really wanted to thank all of the investors and analysts, anyone who's still on the line for all the support over the years.\n\nOur interactions have always been great. I am so proud really of the team. I think you can hear it in the remarks today. I feel like I am going out leaving you in the best possible hands with Billy and Sara and the rest of the team here and Tom, who's still is in the room.\n\nWe're going to let him talk maybe next time. And have a great day. Obviously, if you have any questions, don't hesitate to reach out to Ashley or anyone on the team, Sameer, and thanks a lot for joining. Thank you.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nAshley Serrao -- Head of Treasury and Investor Relations\n\nLee Olesky -- Chief Executive Officer\n\nBilly Hult -- President\n\nSara Furber -- Chief Financial Officer\n\nRich Repetto -- Piper Sandler -- Analyst\n\nKyle Voigt -- Keefe, Bruyette and Woods -- Analyst\n\nCraig Siegenthaler -- Bank of America Merrill Lynch -- Analyst\n\nMichael Cyprys -- Morgan Stanley -- Analyst\n\nAndrew Bond -- Rosenblatt Securities -- Analyst\n\nAlex Blostein -- Goldman Sachs -- Analyst\n\nDan Fannon -- Jefferies -- Analyst\n\nGautam Sawant -- Credit Suisse -- Analyst\n\nAlex Kramm -- UBS -- Analyst\n\nKen Worthington -- JPMorgan Chase and Company -- Analyst\n\nChris Allen -- Citi -- Analyst\n\nBrian Bedell -- Deutsche Bank -- Analyst\n\nMore TW analysis\n\nAll earnings call transcripts"}
{"id": "00db12d4-5e83-4c92-95b9-8eefad204aed", "companyName": "Thomson Reuters", "companyTicker": "TRI", "quarter": 2, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/08/04/thomson-reuters-tri-q2-2022-earnings-call-transcri/", "content": "Thomson Reuters\u00a0(TRI 0.41%)\nQ2\u00a02022 Earnings Call\nAug 04, 2022, 8:30 a.m. ET\n\nOperator\n\nGood day, everyone, and welcome to the Q2 2022 earnings call hosted by Gary Bisbee, head of investor relations. My name is Nica, and I'm your operator today. [Operator instructions] I would like to advise all parties that this conference is being recorded for replay purposes. And with that, I'd like to hand the floor to Gary.\n\nPlease go ahead.\n\nGary Bisbee -- Head of Investor Relations\n\nThank you. Good morning, everyone, and thank you for joining us today for Thomson Reuters second quarter 2022 earnings call. I'm joined today by our CEO, Steve Hasker; and our CFO, Mike Eastwood, each of whom will discuss our results and take your questions following their remarks. [Operator instructions] Throughout today's presentation, when we compare performance period-on-period, we discuss revenue growth rates before currency as well as on an organic basis.\n\nWe believe this provides the best basis to measure the underlying performance of the business. Today's presentation contains forward-looking statements and non-IFRS financial measures. Actual results may differ materially due to a number of risks and uncertainties discussed in reports and filings that we provide from time to time to regulatory agencies. You may access these documents on our website or by contacting our Investor Relations Department.\n\nLet me now turn it over to Steve Hasker.\n\nSteve Hasker -- Chief Executive Officer\n\nThank you, Gary, and thanks to all of you for joining us today. Now on to our Q2 highlights. I'm pleased to report the momentum that has been building in our businesses continued in the second quarter with healthy sales and revenue ahead of our expectations. Four of our five business segments again recorded organic revenue growth of 6% or greater, and total company organic revenues rose 7%.\n\nOur big three business segments also grew 7% organically. We see internal and external drivers of our improving momentum. Solid execution and efforts to better prioritize investments toward our best opportunities have contributed. And we're starting to benefit from meaningful tailwinds driven by a step change in complexity of regulation and compliance in our legal, tax and risk-related markets.\n\nWe believe these tailwinds are in the early innings and position us well to continue our recent momentum over the next few years. Due to the Q2 revenue strength and healthy book of business or annual contract value growth, we are raising our full-year revenue outlook. We now expect to see total revenue rising by 6% and big three revenue by 7%, up from our prior views of 5.5% and 6.5%, respectively. We maintain our margin outlook as we continue to invest in our businesses and also absorb heightened inflationary pressures.\n\nOverall, the strong first half provides confidence that we're on the right path to achieve our 2022 and 2023 targets. While market concerns around slowing economic growth and inflation have increased, our business is well positioned. Our momentum through Q2 was strong, and leading indicators remain healthy. And we're blessed with a resilient business.\n\n80% of our revenue is recurring, and we operate in historically stable and growing end markets. We also benefit from our Change Program efforts, which will significantly boost our margins, cash flow and earnings in 2023. Our capital capacity and liquidity remain a key asset that we are focused on reinvesting to create shareholder value. We took an important step in early June with the announcement of a $2 billion share repurchase program.\n\nThrough July 31, we've purchased $394 million of our shares, and we look to complete the program within 10 months. We also continue to assess inorganic opportunities and expect to have ample capacity for both buybacks and strategic M&A. As a reminder, our acquisition focus includes workflow software and automation in our legal and tax markets and risk, fraud and compliance and targeted international expansion. For example, in legal professionals, we see a sizable opportunity to play a critical role in the tech-driven transformation of the legal profession.\n\nWe are uniquely positioned to provide customers with a smarter, seamless experience through the combination of our highly differentiated research content and expertise with workflow software. The AI-driven contract analysis capabilities we gained through the recent ThoughtTrace acquisition is a step in this direction and builds upon unique capabilities like Practical Law and HighQ. We continue to assess both organic and inorganic opportunities to further expand our capabilities and integrate our leading content with workflow solutions that drive automation and better outcomes for our customers, particularly around legal documents and contract drafting. Now to the results for the quarter.\n\nSecond-quarter reported revenues grew 5% with organic revenues up 7%. Organic recurring revenue again grew 7% with organic transactional revenue up a robust 13%, aided by a calendar shift and the return to in-person events at our Reuters Events business. While we expect transactional revenue growth to moderate in the second half, we see recurring revenue momentum continuing. Adjusted EBITDA increased to $561 million, reflecting 200 basis points margin improvement to 34.7%.\n\nExcluding costs related to the Change Program, the adjusted EBITDA margin was 36.6%. This strong performance resulted in adjusted earnings per share of $0.60, up from $0.48 in the prior-year period. Turning to the second quarter results by segments. The big three businesses achieved organic revenue growth of 7%, reflecting broad strength.\n\nLegal continued its recent momentum, delivering a fifth consecutive quarter of 6% organic growth. The Legal market remains healthy across all key segments: small, mid- and large-sized U.S. firms, government customers and in key overseas markets. For example, Westlaw Edge adoption continues to drive revenue, and we continue to expect annual contract value penetration to approach 75% by year-end from 65% at the end of 2021.\n\nSecond, practical law, which contributes to growth in both corporates and legal segments, continued a strong performance with a quarter of double-digit revenue growth. And third, our Government business grew 8% organically, and we see acceleration as likely in the balance of the year. Turning to corporates. Organic growth momentum continued with revenue up 9%.\n\nRecurring revenue rose a robust 9%, and transactional revenue again exceeded our expectations in writing 8%. I will discuss our corporates business in more detail shortly. Tax and accounting had another strong quarter with organic revenue growth of 9%. Our Latin America business called Dominio grew nearly 30% in the quarter and remains a key growth driver.\n\nReuters News organic revenues increased 12% in Q2. Growth occurred across all lines of Reuters business. Events, in particular, was a key driver. And finally, global print organic revenues declined 1%, which was better than expected due to higher third-party print revenues and timing benefits that we expect to normalize in the remainder of 2022.\n\nIn summary, we're very pleased with these results, and we're excited about the momentum that's building within our businesses. Now let me take a few minutes to discuss our corporates segment and our risk, fraud and compliance businesses and why we are confident in the growth prospects of both. As we did last quarter, I'd like to provide some incremental transparency around our portfolio with a brief discussion of our corporates segment and our risk, fraud and compliance or RFC businesses. Beginning with corporates, some brief background may be useful.\n\nThe segment was formed in the fourth quarter of 2018 to better serve, innovate for and penetrate corporate users for our key legal, tax and RFC offerings. Corporates is the No. 1 provider of both legal and tax solutions for corporations in the United States and serves all of the Fortune 100. Momentum has built nicely over the last year with corporates organic revenue growth accelerating from 4% in the first half of 2021 to 6% in the second half and 8% in the first half of this year.\n\nFor full year 2022, we are confident in achieving the 7% to 9% organic growth target we previously set for 2023. So what's driving this momentum? We see strong growth from a range of offerings across all three product areas. Key double-digit growers, which are circled in green on the slide, include indirect tax and confirmation from our tax portfolio, practical law and HighQ from legal and CLEAR from RFC, among others. In total, double-digit growers in our corporates product portfolio comprised 39% of segment revenue and are growing at a mid-teens year-over-year rate.\n\nAs we described last quarter for our legal professionals segment, a healthy mix shift toward these more rapidly growing offerings is contributing to our corporates momentum. Looking forward, we remain confident in the long-term growth potential for the segment driven by our building momentum, a healthy product portfolio and corporate demand for actionable insights and efficiency-driven workflow tools combined with significant addressable market and whitespace penetration opportunities. Building upon this corporates discussion, I'll expand on our risk, fraud and compliance businesses. We have historically discussed RFC as part of our legal professionals government subsegment, which also includes our legal offerings sold into government and core customers.\n\nHowever, our RFC businesses are also an important driver for corporates, which generates a bit over 40% of our RFC revenue. We have several businesses that make up our RFC franchise, led by CLEAR, a leading public record solution. This is complemented by Thomson Reuters Special Services or TRSS and Pondera. TRSS provides a combination of information, technology and security-cleared analysts to support government customers in mitigating global risk and improving public safety.\n\nPondera provides a cloud solution that leverages advanced algorithms to help detect fraud in government entitlement programs. Both TRSS and Pondera leverage CLEAR data, adding insight and decisioning capabilities that extend our value add. Our RFC businesses have contributed nicely to growth with total RFC revenue expanding by a 16% compound annual growth rate over the last five years and CLEAR growing by double digits in every year since it was acquired in 2008. There have been several key drivers of this growth, including an expanding number of use cases across government and corporate customers, enhanced functionality that has bolstered usage and pricing and growth of access through APIs, which has also boosted our partnership efforts.\n\nLooking forward, we believe that our RFC businesses are well positioned to deliver revenue growth in the teens over the next few years. We also believe our current position is a strong platform from which to consider future M&A in the RFC space. Let me go a little bit deeper on CLEAR, which makes up approximately two-thirds of our RFC revenue. CLEAR is a leading public records database and analytics solution powered by proprietary technology and a highly unique data set.\n\nIt brings billions of data points from public records and third-party data bases together to deliver insights for investigative, compliance, risk mitigation and fraud prevention purposes. Historically, CLEAR has focused on building an aggregated data set that enables investigators to perform a single search across multiple sources to uncover connections and identify risk-related information aided by customizable and easy-to-navigate dashboards. This enhanced due diligence use case remains an important revenue growth -- revenue and growth driver today. In recent years, we've added decisioning tools and configurable analytics around identity verification and entity risk indicators and scoring.\n\nWe've also added incremental content, including sanctions lists and business beneficial ownership data. These additions have resulted in a more robust offering that has expanded customer user base pricing. And they are adding to our growth runway and our customers' success. We believe CLEAR is a market leader with several advantages, including robust identity resolution technology, comprehensive content, real-time data connections, strong data source transparency and a compelling analytics-driven dashboard.\n\nOur CLEAR product NPS scores for both government and corporate users are among the highest in the company, which speaks to the value customers see in this important offering. The graphic on Slide 12 illustrates how CLEAR can help customers prevent, detect and investigate risk and fraud by answering key questions about their potential customers or counterparties. These questions demonstrate the critical need for a deep understanding of entities, both people and companies, relevant for government and corporate customers across numerous use cases ranging from criminal investigations to identifying human trafficking networks to KYC and AML compliance as well as others. To bring our RFC efforts to life, let me close with a real-world example from our Government business.\n\nDuring the initial pandemic period, unemployment insurance claims skyrocketed, and unfortunately, so did fraud-related activity. The State of California processed more claims than any other state and initially struggled to process claims while minimizing fraud. It turned to a combination of our solutions using Pondera's algorithms and AI in combination with CLEAR and the state's own data to identify and verify legitimate claims and highlight potential fraudulent claims. This solution helped the state work through a backlog of 9.7 million claims in a two-week period while accelerating payments to qualified recipients and denying fraudulent claims.\n\nSince implementation, Thomson Reuters has been a key partner in helping California to stop $125 billion of fraudulent claims. We're proud of the work done by our risk, fraud and compliance teams, which help support safe communities, uphold the integrity of government entitlement programs and support robust compliance efforts. Now let me turn it over to Mike, who will provide more detail on the second-quarter results.\n\nMike Eastwood -- Chief Financial Officer\n\nThank you, Steve, and thanks for joining us today. As a reminder, I will talk to revenue growth before currency and on an organic basis. Let me start by discussing the second-quarter revenue performance of our big three segments. Revenues rose 7% organically and at constant currency for the quarter.\n\nThis marks the fifth consecutive quarter our big three segments have grown at least 6%. Legal professionals organic revenues increased 6%. This also marks the fifth consecutive quarter of 6% growth for legal professionals. Organic growth was driven by practical law, FindLaw and our government business.\n\nWestlaw Edge continues to add about 100 basis points to legal's organic growth rate. It is maintaining a healthy premium and is expected to continue to contribute at a similar level going forward, supported by the planned release of Westlaw Edge 2.0 later this year.In our corporates segment, organic revenues increased 9% for the quarter driven by recurring revenue growth of 9% and transactional revenue growth of 8%. CLEAR, practical law and indirect tax were key drivers of the recurring revenue. The transactional revenue growth benefited from volumes that are seasonal in nature and is unlikely to continue at that level in the second half of the year.\n\nHowever, we see recurring revenue growth momentum continuing. And finally, tax and accounting's organic revenues grew 9% driven by recurring revenue growth of 11%. Organic growth was driven by Ultra Tax, audit products and the segment's businesses in Latin America. Moving to Reuters News.\n\nTotal and organic revenues increased 12%, exceeding expectations due to strength in our professionals business. In particular, Reuters Events drove the growth as it benefited from both a favorable event calendar shift into Q2 and also the return of in-person events. We expect more moderate growth from Reuters News in the second half of the year. Lastly, global print total and organic revenues declined 1% in the second quarter ahead of expectations.\n\nHigher third-party revenues for printing services and timing of new sales drove the outperformance. So we expect both to normalize in the remainder of 2022. On a consolidated basis, second quarter organic revenues increased by 7%. Turning to our profitability.\n\nAdjusted EBITDA for the big three segments was $524 million, up 8% from the prior-year period with a 40.7% margin rising 80 basis points. Improvement over prior-year period was due to higher revenues and Change Program savings. As a reminder, the Change Program operating costs are recorded at the corporate level. Moving to Reuters News.\n\nAdjusted EBITDA was $44 million, up $9 million from the prior-year period with a margin of 23.3%, up 310 basis points. Revenue growth and higher events mix drove margins. Global Print's adjusted EBITDA was $50 million with a margin of 35.4%, a decline of 250 basis points due to the decrease in revenues and the dilutive impact of lower margin third-party Print revenue. In aggregate, total company adjusted EBITDA was $561 million, a 12% increase versus Q2 2021.\n\nExcluding costs related to the Change Program in both periods, adjusted EBITDA increased 9%. The second quarter's adjusted EBITDA margin was 34.7% or 36.6% on an underlying basis, excluding costs related to the Change Program. Turning to earnings per share. Second quarter adjusted EPS was $0.60, up from $0.48 in the prior-year period.\n\nThe increase was mainly driven by higher adjusted EBITDA. Currency had a $0.01 positive impact on adjusted EPS in the quarter. Let me now turn to our free cash flow performance for the first half. Reported free cash flow was $428 million versus $618 million in the prior-year period.\n\nConsistent with previous quarters, this slide removes the distorting factors impacting our free cash flow. Working from the bottom of the page upwards, the cash outflows from the discontinued operations component of our free cash flow was $25 million more than the prior-year period. This was due to payments to the U.K. tax authority related to the operations of our former Refinitiv business.\n\nAlso in the first half, we made $186 million of Change Program payments as compared to $28 million in the prior-year period. If you adjust for these items, comparable free cash flow from continuing operations was $685 million, $7 million lower than the prior-year period primarily due to higher annual incentive plan bonuses. We reaffirm our 2022 full-year free cash flow outlook of approximately $1.3 billion. I will now provide an update on the progress related to our Change Program.\n\nIn the second quarter, we achieved $64 million of annual run rate operating expense savings. This brings the cumulative annual run rate Change Program operating expense savings to $369 million.This increases our confidence in reaching approximately $500 million of annualized savings by year-end and $600 million gross operating expense savings by 2023. As a reminder, we anticipate reinvesting $200 million of the projected $600 million of savings back into the business for a net savings of $400 million. Now an update on our Change Program costs for the second quarter and the remainder of 2022.\n\nLet me start by saying none of the annual estimates have changed from what we provided last quarter. Spend during the second quarter was $67 million, comprised of $30 million of opex and $37 million of capex. We anticipate $175 million of total spend in the second half of 2022. For the full year, we continue to expect $305 million of Change Program investments, which would bring total 2021 and 2022 cumulative investments to approximately $600 million.\n\nWe also continue to anticipate a split of roughly 60% opex and 40% capex. Let me conclude with our outlook for 2022 and 2023. As Steve outlined, we have increased our full year 2022 outlook for total TR and big three revenue growth. We now forecast total organic revenue growth of approximately 6% and big three organic revenue of approximately 7%, up from the prior 5.5% and 6.5%, respectively.\n\nWe are maintaining our adjusted EBITDA margin outlook of approximately 35% as we continue to monitor inflationary impacts and assess investment opportunities to drive continued revenue momentum. There is no change to other 2022 outlook items, and we reaffirm our 2023 targets. Looking to the third quarter, we expect revenue growth to be 50 to 100 basis points below the updated full-year forecast due to lower transactional revenue and more normalized growth rates for Reuters News and Global Print. However, we expect fourth-quarter revenue growth to improve from Q3.\n\nWe expect recurring revenue to expand by 7% for the full year. We expect our third quarter adjusted EBITDA margin to decline 300 basis points sequentially from Q2 due to normal seasonality, timing of Reuters Events and the cadence of Change Program investments. We expect Q4 margins to be the high watermark of the year, aided by seasonal strength from our Tax Professionals segment and scaling Change Program savings. We see our effective tax rate likely at the midpoint of our 19% to 21% full-year range.\n\nIn summary, we remain confident in achieving our 2022 and 2023 targets, supported by the strong first half and healthy underlying momentum in our key businesses and markets. Over time, we continue to believe we can achieve faster revenue growth, higher profitability and significantly higher free cash flow as we benefit from transforming to a content-driven technology company. Let me now turn it back to Gary for questions.\n\nGary Bisbee -- Head of Investor Relations\n\nThank you, Mike and Steve. Nica, we're ready to begin the Q&A.\n\nOperator\n\n[Operator instructions] And the first one is coming from Toni Kaplan of Morgan Stanley.\n\nToni Kaplan -- Morgan Stanley -- Analyst\n\nTo raise the '22 organic growth guidance by 50 basis points, which is great to have a few quarters in a row of raising the guidance there, so congrats on that. I noticed you didn't raise '23. Is that conservatism or concern about potential recession in '23? Or do you just need to go through your in-depth planning process first? Just what drove sort of the decision not to raise '23?\n\nMike Eastwood -- Chief Financial Officer\n\nYes. It's more of the latter, Toni. We certainly remain very confident in delivering on our 2022 updated guidance. We remain confident in delivering on our 2023 targets as we provided.\n\nWe're very confident in our team. We're very confident in our execution, but we think it's very prudent given the various macro factors to wait to complete our full-year planning process in the next few months. And we look forward to providing an update on our 2023 guidance in February. But based on the first half of the year, the strength of our underlying book of business and the execution of our sales and go-to-market team, the execution against our Change Program, confidence is very high.\n\nBut it's more what you mentioned, Toni, in regards to going through the planning process and being very prudent in assessing the macro factors, but all signals are very positive.\n\nSteve Hasker -- Chief Executive Officer\n\nYes. Toni, it's Steve. Just adding to that. So Mike and Dave Larsen conduct our QBR fully business review process, and that comes in late September, October.\n\nAnd as you know, we have 80% of our revenue is recurring. We have a very high percentage of multiyear contracts across our big three segments. So we've got good visibility, but we want to get through that process and be very diligent about it before we make any sort of further predictions.\n\nMike Eastwood -- Chief Financial Officer\n\nJust one additional point there, Toni, in regards to that getting through the plan process. You mentioned also, as we complete the year, the visibility to Steve's point at 80% is recurring in nature. Our book of business will have good line of sight as we complete Q3 and Q4, which will give us a good visibility as we go into the February earnings call.\n\nToni Kaplan -- Morgan Stanley -- Analyst\n\nGreat. And hoping you could sort of talk about, has the macro changed? Have any client conversation?\n\nSteve Hasker -- Chief Executive Officer\n\nToni, thanks for the question. So as you know, we like to spend an enormous amount of time with customers and getting a deeper and deeper understanding of their businesses. I think based on my conversations with the heads of small, medium, large law firms, tax and accounting firms and some of our corporate and government customers, I would say that to date, their results have been pretty solid. I mean, the law firms had record results in 2021.\n\nAnd so far, in 2022, they've seen pretty robust demand through their litigation practices through their restructuring. The corporate practices are a bit soft, fewer IPOs, fewer debt issuance. But I think the -- our customer base has the same stance that we have, which is sort of proud of results to date, but I think a bit of healthy paranoia as to what might come next and just watching very, very carefully for some early signs of softness. But we haven't seen it yet, and most of our customers haven't seen it yet either.\n\nMike Eastwood -- Chief Financial Officer\n\nYes. Toni, I would supplement with two additional points that we monitor our renewal rates or retention rates. Retention rates are slightly higher in 2022 thus far than 2021. As a reminder, we have a lot of multiyear contracts and also on the pricing front, our pricing is slightly higher in 2022 versus 2021.\n\nAnd then the third quantitative measure is our sales pipelines that we monitor with all of our segments, subsegments and regions. Do we have a second question?\n\nOperator\n\nYes. We do. Ad that is coming from the line of Tim Casey of BMO.\n\nTim Casey -- BMO Capital Markets -- Analyst\n\nYes. Two for me. Just quickly, I know it looks like you did an acquisition in the quarter. Could you just talk a little bit about what happened there? And, Steve, a question for you, just a recurring one really.\n\nJust wondering if you can give us an update on your assessment of the -- I guess, the progress you've made and the shortcomings to date of your initiative to improve really the customer experience? I know that's been a primary focus and things like customer interfaces and whatnot. What's your assessment of where you are on that journey?\n\nSteve Hasker -- Chief Executive Officer\n\nYes. Thanks, Tim. Great question. So our most recent acquisition was of a business called ThoughtTrace, which is based in Houston, Texas, run by a very talented executive by the name of Nick Vandivere.\n\nThoughtTrace, we think, is the leading AI-driven contract analysis tool. Nick and his team are focused today on oil and gas, particularly oil and gas leasing contract. But we've done a lot of work with them prior to the closing of the acquisition and as you can imagine, an awful lot more since closing the acquisition as to how we can extend that capability into a broader set of commercial verticals. So whether that's financial services or pharmaceutical or you name it, we're looking at it.\n\nAnd so it's a small acquisition for us. It's very much at the cutting edge and the application of AI and machine learning to our unique content, but we like to look at that. And Emily Colbert and Kriti Sharma from our teams, among others, have been focused on building that out. The second part of your question with relation to the Change Program.\n\nLook, it's a complicated program with many moving parts, as you know, Tim, but we have spent a good chunk of the $600 million onetime investment. Mike talked about the run rate savings that are accruing from that and how it positions us for 2023. So from a financial standpoint, the Change Program is in great shape, and it's delivering what we expected it to. I think the sort of components that are going among a number of the components that are going very well would be our cloud conversion, firstly.\n\nSecondly, the progress that Jason Escaravage, cyber leader, has made in terms of addressing our strengths around cyber fraud and compliance. Thirdly, digital assist. So the idea that a customer will have a whole series of digital sales support and renewal capabilities. They have been well received and are very popular.\n\nAnd then last but not least, we've done a lot of work on our location strategy and where we want our go-to-market talent, where we want our product and engineering talent and so on and so forth. And that that's being led by Kirsty and her teams and is doing well, too. I would say we still have a lot to get done through the balance of this year and into next. And mainly, it's converting these investments and capabilities into customer satisfaction.\n\nI think there are pockets where the customers are really starting to see it, and there are other customers where they're not yet. And so we're laser-focused on that conversion. And I'd call out our go-to-market leaders for navigating their way through this environment with the backdrop of the pandemic, the backdrop of inflation and increasingly, economic unease, an enormous amount of change and disruption being driven by the Change Program. And yet, our price has gone up a little bit, our renewal has gone up a little bit, and our organic growth is headed in the right direction notwithstanding all of the disruptions and turmoil that we've imposed on ourselves.\n\nSo I'd say the punchline, Tim, is so far so good on the Change Program with lots of work left to do.\n\nMike Eastwood -- Chief Financial Officer\n\nYes. Tim, I'll just add one additional data point in regards to the cloud migration. We provided back in February that we had 37% of our revenue available in the cloud at the end of 2021. At the end of June, we were 47%.\n\nWe forecast to be at 60% by the end of '22, and we remain confident in being at 90% by the end of 2023, which is consistent with our prior estimates. Nica, additional questions?\n\nOperator\n\nThe next question is coming from the line of Kevin McVeigh of Credit Suisse.\n\nKevin McVeigh -- Credit Suisse -- Analyst\n\nCongratulations on the results. I guess, Steve or Mike, the 50 basis point boost to the organic growth guidance, was that pricing, retention, a little bit of everything? Or I guess, what gave you the confidence to do that, number one. And then can you talk about retention just a little finer in terms of maybe upmarket versus down versus mid, and you're starting to see any initial benefits from the Change Program around retention?\n\nMike Eastwood -- Chief Financial Officer\n\nSure, Kevin. Let me focus on the guidance question first. The increase in 50 basis points for total TR and the big three was really driven by the underlying performance and health of the business. Prices included therein, but price is up only slightly, Kevin, in 2022 versus 2021.\n\nThat will continue to increase as we progress in '22 and '23, given the multiyear contracts, as I mentioned earlier, in regards to Toni's question there, so primarily the underlying health of the business. The book of business that we have, Kevin, at June 30, coupled with the pipeline for the remainder of the year, were really the drivers for us increasing our guidance by the 50 basis points. In regards to retention, we're seeing slight increases across the firm, but we still have significant opportunity on a weighted average basis using revenue as the benchmark, not number of customers. But based on revenue, we're slightly over 91%.\n\nSo we continue to have a lot of opportunity to improve our retention and the time horizon as we continue to address the underlying customer experience items that Tim addressed during his questions there. So a little bit of improvement in price, a little improvement in retention, but we continue to have opportunity in retention. And just a reminder, Kevin, our recurring revenue growth rate, we're forecasting at 7% for the full year. Each quarter is roughly 7% rounded.\n\nSo a couple of quarters a little higher, a couple of quarters a little lower. As we go into Q3, Q4, the comps are a little higher. So hopefully, that's helpful, Kevin. Nica, please?\n\nOperator\n\nNext we have a question from Aravinda Galappatthige of Canaccord Genuity.\n\nAravinda Galappatthige -- Canaccord Genuity -- Analyst\n\nSteve, when you talked about the M&A criteria, you touched on the legal software and workflow space. Can you just sort of revisit the size of that market? I know that it's encumbered right now seemingly by some mid-tier companies. Are you kind of looking at that space as sort of simply just being large enough, and you being positioned to kind of take share there? Or do you even look at sort of the industry participants as relatively weaker, and that kind of gives TRI even maybe some incremental opportunity? Just wanted to get your sort of expanded thoughts there. And then secondly, just with respect to 2023, maybe for Mike, when you think about inflation, I mean, obviously, you have a significant labor component.\n\nCan you just talk about how that changes the puts and takes there, recognizing, of course, that there may be some opportunities to sort of move rates around as well on the recurring -- on the subscription front? Any color would be helpful there.\n\nSteve Hasker -- Chief Executive Officer\n\nYes. Thanks, Aravinda. Let me quickly address the first point. So as you know, we've got a pretty robust pipeline of M&A that we're looking at.\n\nWe're optimistic that the valuations are coming our way versus the other way around, but we'll be very rigorous, very disciplined and patient about going after them. Focused on automation, workflow automation tools that drive efficiency and take many hours out of key tasks for our legal, tax and accounting and risk, fraud and compliance, government customers, that's really the sort of area of focus also with an eye to some selected international expansions. Within legal, yes, look, we're very bullish. What we see is an industry that is at the start of a transformation.\n\nAnd it's an information- and tech-driven transformation. So for many years, the legal profession has been reasonably slow to move and slow to adopt technologies. And we've seen that change pretty markedly coming out of the pandemic. So every head of a law firm is asking us the questions around how can our tools, how can our research content and our tools combined help them be less reliant on hiring new lawyers or additional lawyers to drive growth.\n\nSo they want to create a different set of economics and a different vibe within their firm. And we're one of the few players that's well positioned to take advantage of that. So as we look at the life cycle management, document management, further workflow tools, we see a pretty big opportunity. And the TAM is growing in a meaningful way because traditionally, it's a profession that's underspent on information and technology and arguably overspent on real estate.\n\nAnd that is being addressed pretty aggressively by the leading firms. We think it provides a pretty big opportunity. So that's a few thoughts on the first part of your question.\n\nMike Eastwood -- Chief Financial Officer\n\nYes. Aravinda, on the second part of the question in regards to 2023 and inflation, I would say both for 2022 and for our 2023 guidance based on how we see inflation of top line and bottom line, we have fully incorporated our current view into '22 and '23 guidance. To your point there on labor, we certainly provided higher merit increases in 2022. We're working very closely with our HR team, chief people officer in regards to 2023 there.\n\nBut we think we factored in the appropriate increases for the labor cost. The other element of inflation that we monitor with Jennifer Prescott leading the Print businesses, paper, print and postage, we've certainly received incurred some inflationary increases on the cost there, but we've been able to offset majority of that with our pricing. So managing pricing coupled with the increased labor cost and other costs. We think we're managing all of those aspects very well.\n\nAs you mentioned, there are a lot of puts and takes. But with those puts and takes, we think we've fully incorporated them into our guidance for '22 and '23. Nica?\n\nOperator\n\nThe next question is coming from the line of Heather Balsky of Bank of America.\n\nHeather Balsky -- Bank of America Merrill Lynch -- Analyst\n\nI was curious if you can just talk about some of the sort of incremental areas you're investing in. You talked about on the margin keeping kind of guidance the same for opportunity to invest. What are the organic opportunities you're most excited about?\n\nMike Eastwood -- Chief Financial Officer\n\nYes. I'll start with that, Heather. First, I would say that we're continuing to invest in our Change Program where we've centered that on improving our customer experience. I think Steve itemized a number of items earlier that involved the Change Program.\n\nSo I'd say first, we're continuing to execute that. A lot of lifting still in Q3, Q4. But I think the team has a very good glide path to work on the Change Program items. In regards to other areas of investment, I would highlight our product and engineering.\n\nFirst, our Westlaw Edge 2.0, which will be released later this year within Legal. That's an important area for us. Practical Law that we highlighted during our May 3 earnings call, Practical Law helps both our law firm customers and also our general counsel customers within corporate. risk, fraud and compliance, as Steve discussed today, impacts both our government customers and also our corporate customers is another area Steve referenced earlier, certainly HighQ that we acquired back in July of 2019 is a key area for us.\n\nOver within our tax and accounting professionals business, Ultra Tax that I referenced during the prepared remarks today, Confirmation that we acquired in July of 2019 continues to perform incredibly well under Elizabeth Beastrom's leadership. We also have leverage there within our corporate customers. So outside of our Change Program, Heather, the key focus for us is in regards to investing in our products to help our customers there. And it's very balanced across our portfolio, including within our Latin America region and also Asia and emerging markets.\n\nSteve Hasker -- Chief Executive Officer\n\nYes. I mean, it's -- if you go back to our Investor Day presentations at the start of last year, we talked about seven growth initiatives. We continue to invest behind those because we're seeing good results, and we're excited about where they can take us.\n\nHeather Balsky -- Bank of America Merrill Lynch -- Analyst\n\nHelpful. And as a follow-up, when you think of 2023, if there is a downturn, if you were to see some sort of sales impact on the margin side, you have the benefit of the cost cutting with Change Program. But more broadly, how are you thinking about margins and the things you can control?\n\nMike Eastwood -- Chief Financial Officer\n\nYes. I think, Heather, for '23, we remain confident in achieving our guidance of 39% to 40%. In regards to any revenue headwinds, where we would potentially see those first would be in transactional revenue, which includes our Reuters Events. I'd say Reuters Events is having an incredibly good year, over $20 million of revenue in Q2 for us there.\n\nTransactional certainly did well in the first half of the year. As I mentioned, we expect it to normalize in the second half for us. But for margin, 39% to 40% back to our Aravinda's point, we have lots of puts and takes that we can manage and pull. And we feel confident in delivering 39% to 40% in 2023.\n\nAnd we have enough levers to effectively manage through while supporting our employees and our customers.\n\nSteve Hasker -- Chief Executive Officer\n\nYes. Not -- Heather, not to be flippant about it, but should we head into a recession, be it a broad and deep one or a relatively shallow one, we view it as an opportunity, an unequivocal opportunity to emerge stronger relative to our customers and be better able to -- relative to our competitors and better able to serve our customers. We have No. 1 and No.\n\n2 positions in just about every market in which we operate. And we think a more difficult economic backdrop will provide us with an opportunity to further those leads, which should it happen, we'll be looking forward to.\n\nMike Eastwood -- Chief Financial Officer\n\nYes. Heather, back to your first questions on areas of investment. I think the areas of investments just intentionally make it stronger as we go through '22 and certainly position us, to Steve's point, for '23. So we think they go hand in hand.\n\nNica?\n\nOperator\n\nNext, we have a question from the line of Drew McReynolds of RBC.\n\nDrew McReynolds -- RBC Capital Markets -- Analyst\n\nLate coming on to the call, so I apologize if you've covered this off. Maybe Mike, just an update on Westlaw Edge 2.0, if that's still on track for some launch in the back half of this year. And maybe a bigger picture question. It's my understanding in terms of comps and internal AI and machine learning capabilities, you went down that path many, many years ago.\n\nAnd obviously, you're leveraging it into products like Westlaw Edge. Just wondering, as the AI and machine learning markets have evolved over the last five or six years, could you speak to your internal capabilities to keep pace with that kind of innovation versus your M&A strategy where you look to different companies with these capabilities perhaps to backfill your own internal kind of innovation machine. So sorry for the kind of broad motherhood big picture question, but just curious just what you just acquired in the quarter.\n\nMike Eastwood -- Chief Financial Officer\n\nDrew, great questions. Let me tackle Westlaw Edge 2.0. Drew, we confirm that we will launch Westlaw Edge 2.0 in the second half of this year. Steve and I have had multiple sessions, demos from Andy Martens, Mike Dane, Paul Fischer, David Wong, in the last few weeks.\n\nI think you'll be incredibly pleased. More importantly, our customers will be super pleased when we launch it later this year. So fully on target there. In the meantime, Drew, the team, our go-to-market team within legal professionals and corporates, they continue to work with our customers on Westlaw Edge 1.0.\n\nWe're approaching 70% penetration with Westlaw Edge 1.0, but 2.0 will definitely launch later this year, Drew. And look forward to sharing it with all of you and our customers. I think Steve will address the AI/ML question.\n\nSteve Hasker -- Chief Executive Officer\n\nYes. So we have a couple of hundred AI and ML and world-class experts in TR Labs. And so those folks are spread throughout the world. There's quite a number of them here in Toronto.\n\nThere are a number in London, in New York into -- and in other operating centers like MSP and another in Dallas. And we're very proud of the work they do. They have been instrumental in Westlaw Edge 1.0 and have been, I think, even more influential as we think about the launch of 2.0. So the proof is there.\n\nI think we are keeping up with a changing environment, if not outrunning it, which is obviously no mean feat. And the opportunity for us is to along the lines of being a content-driven technology company is to increasingly add AI, machine learning to our unique content and best-of-breed software. We've done more of that in the legal professionals area, but we are starting to ramp those efforts up across the portfolio, including in tax and accounting and risk, fraud and compliance, among others.\n\nDrew McReynolds -- RBC Capital Markets -- Analyst\n\nSuper. And maybe one last quick one. Back to you, Steve. Just you spoke about taking advantage of your No.\n\n1, No. 2 positions in a downturn. Just before we get to that phase, as your kind of peers coming out of COVID and not that these are only your peers, but Wolters Kluwer and RELX, are you seeing any change in their capabilities, their ability to execute on all the things they're trying to capitalize on post COVID? Just any change in the competitive dynamic, that would be great.\n\nSteve Hasker -- Chief Executive Officer\n\nNo, Drew. As you know, we have towering respect for our traditional competitors and the new and emerging competitors. So we don't take it lightly, and without doing it, we do keep abreast of what they're up to. I don't discern any meaningful change in competitive intensity or rate of innovation from our customers at the moment, but we'll stay on top of that.\n\nOperator\n\nNext, we have a question from Andrew Steinerman of J.P. Morgan.\n\nStephanie Yee -- J.P. Morgan -- Analyst\n\nIt's Stephanie stepping in for Andrew. Thanks for all the color you provided on the corporates segment. I was wondering if you can talk about your positioning in indirect tax relative to competitors in the marketplace. Is Thomson gaining market share in that area?\n\nSteve Hasker -- Chief Executive Officer\n\nYes. Thanks, Stephanie. So our indirect tax proposition, I would say, in terms of its size is not a No. 1 or No.\n\n2 to the earlier points made but is closer to three or four. So we tend to compete at the high end of the market with Vertex. And I think we're holding our own or a bit better there. It is one of the seven -- so one of our seven growth verticals that we announced at Investor Day last year.\n\nSo we've been investing in it and building the capability and the team, and we're proud of the efforts. [Inaudible] in a different territory. They've come from the SMB space, but are trying to move up the scales there. And of course, Sovos, which is private equity owned, have a pretty robust portfolio.\n\nIt's a somewhat fragmented portfolio but a robust portfolio. So I think this is an area where we're seeing robust growth -- industry growth in the mid-teens. We're matching that, but we'd like to -- we'd certainly like to have a bigger, more robust presence and move into a No. 1 or No.\n\n2 position over time. And we'll be sort of thoughtful and rigorous about how we might get there.\n\nOperator\n\nAnd so the next question is coming from the line of Scott Fletcher of CIBC.\n\nScott Fletcher -- CIBC World Markets -- Analyst\n\nI just have a question on the sales cycle and the impact of macro headwinds and your comments around sort of that healthy paranoia and whether it's extending sales cycles, given some more scrutiny on or different levels of review as you go through the new sales cycle.\n\nMike Eastwood -- Chief Financial Officer\n\nYes, Scott, thank you. In regards to the sales cycle, we're not -- we're watching it, as you can imagine, incredibly closely with all of our segment leaders and subsegment leaders there. We're not seeing any noticeable change right now in the length of our sales cycle.The one that's probably the trickiest for us is within our government business, and it's really nothing new. But just given the government procurement process, it's a little bit more variable in nature, a little bit less predictable than our other businesses right now.\n\nBut we're not seeing any significant change right now in the sales cycle or length thereof.I do credit, Scott, our sales team for that, both our direct sales reps, but also account managers, client managers, customer success managers, all the different resources that we apply to supporting our customers there. But that's one that we're watching closely, and we'll keep you updated in future quarters.\n\nSteve Hasker -- Chief Executive Officer\n\nYes. And the other thing to note is that we're investing in our growth initiatives, particularly around tools that drive efficiency. The conversations remain very healthy with customers, where they can see a tangible, measurable increase in their own efficiency. So fewer hours required to achieve core tasks, fewer bodies required to achieve core tasks.\n\nThat's really a big area of focus. And that embraces Westlaw and practical law, HighQ, ThoughtTrace and extends into our tax and accounting propositions.\n\nMike Eastwood -- Chief Financial Officer\n\nYes, Scott. Two additional points I would mention just in the last two and a half years, I think our teams, sales, go-to-market teams have done a hell of a job adjusting in this hybrid environment, virtual environment, supporting our customers that way. We do have our annual meeting with our sales leaders coming up in mid-August. That will give us additional time to get direct impact.\n\nBut right now, we're not seeing any significant change, Scott.\n\nOperator\n\nThe next question is coming from -- yes, sorry. We have a question from Manav Patnaik of Barclays.\n\nUnknown speaker\n\nThis is Brendan on for Manav. Just wanted to ask real quick on the guidance. Obviously, revenue is up 50 bps twice over the last two guidance increases. You kept margin at 35%.\n\nJust want to -- is the bias there or simply just a bit higher costs from cost from inflation or investments? Or how should we think about that?\n\nMike Eastwood -- Chief Financial Officer\n\nYes. Three items I would mention, Brendan. First is certainly we have made incremental investments. You're specifically focused on margin, but we've made incremental investments in both opex and capex as we see opportunities to sustain and accelerate our organic revenue.\n\nSecondly, to your point, Brendan, certainly, inflation. Here, I think we're doing a good job managing the puts and takes, as I've discussed earlier, but certainly inflationary pressures is one that we're watching very closely. And then thirdly, I would mention we're being very prudent, eyes wide open on macro factors just during the remainder of the year. So I think the convergence of those three items that we're closely monitoring and investing in are the reasons why we maintained the margin at approximately 35% for the full year.\n\nBut we're confident in delivering on that, Brendan.\n\nOperator\n\nAnd the last question is coming from the line of Douglas Arthur of Huber.\n\nDouglas Arthur -- Huber Research Partners -- Analyst\n\nSteve, just a sort of big picture question. When you talk about technology work solution adoption at the big law firms, among others, is that enhanced by sort of a generational change in the leadership? I mean, I think of some of the old-time law partners that I know, and if you walk into their office and start talking about AI and cloud-based solutions, they look at you blankly. So -- but there does seem to be a younger group of managers, and I'm wondering if that's sort of accelerating adoption?\n\nSteve Hasker -- Chief Executive Officer\n\nYes, Doug. It is for sure. I mean, if you sort of looked at our business 5 or 10 years ago, you'd see on the research side, a knowledge -- chief knowledge officer or a librarian who was very much the sort of gatekeeper and curator of the research content for the practicing attorneys. Now more and more, the attorneys themselves would look direct into our products, and they're very adept at doing so and providing us feedback.\n\nAnd we do our best to incorporate that feedback into subsequent releases. So I think that is very much the trend. The other thing that occurred during COVID among the senior most longest-tenured lawyers, including managing partners, because they went to work from home for the first time in their careers. And as one of them joked with me, he said, \"I become my own IT guy, right? So I didn't have a clue how to do any of the stuff for the pandemic and now have no choice.\" And I think -- so even the longest tenured folks are starting to adopt technologies and getting much more comfortable with directly using our products.\n\nAnd that's a really healthy dynamic for our business because the more users are directly exposed to the experience and as we invest behind Charlie Claxton and our UX and design teams to improve that, we think the stickiness of those products goes up, and the chances of renewal at healthy price increments goes up, too.\n\nMike Eastwood -- Chief Financial Officer\n\nI think, Nica, I think that's the last question. We really appreciate everyone's time today.\n\nOperator\n\nThank you very much, everyone. That concludes your conference call for today. You may now disconnect. Thank you for joining, and enjoy the rest of your day.\n\nSteve Hasker -- Chief Executive Officer\n\nThank you.\n\nDuration: 0 minutes\n\nGary Bisbee -- Head of Investor Relations\n\nSteve Hasker -- Chief Executive Officer\n\nMike Eastwood -- Chief Financial Officer\n\nToni Kaplan -- Morgan Stanley -- Analyst\n\nTim Casey -- BMO Capital Markets -- Analyst\n\nKevin McVeigh -- Credit Suisse -- Analyst\n\nAravinda Galappatthige -- Canaccord Genuity -- Analyst\n\nHeather Balsky -- Bank of America Merrill Lynch -- Analyst\n\nDrew McReynolds -- RBC Capital Markets -- Analyst\n\nStephanie Yee -- J.P. Morgan -- Analyst\n\nScott Fletcher -- CIBC World Markets -- Analyst\n\nUnknown speaker\n\nDouglas Arthur -- Huber Research Partners -- Analyst\n\nMore TRI analysis\n\nAll earnings call transcripts"}
{"id": "00db3ed8-87f9-4723-b7b6-a3ea5ee688b8", "companyName": "DHT Maritime", "companyTicker": "DHT", "quarter": 1, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/05/10/dht-maritime-dht-q1-2022-earnings-call-transcript/", "content": "DHT Maritime\u00a0(DHT -0.27%)\nQ1\u00a02022 Earnings Call\nMay 10, 2022, 8:00 a.m. ET\n\nOperator\n\nGood day and thank you for standing by. Welcome to the DHT Holdings Q1 2022 earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded, Tuesday, the 10th of May 2022. [Operator instructions] I would now like to turn the conference over to our speakers today.\n\nLaila Halvorsen, CFO, and Svein Moxnes Harfjeld, CEO and President of the company. Please go ahead.\n\nLaila Halvorsen -- Chief Financial Officer\n\nThank you. Good morning and good afternoon everyone. Welcome and thank you for joining DHT Holdings first quarter 2022 earnings call. I'm joined by DHT's president and CEO, Svein Moxnes Harfjeld.\n\nAs usual, we will go through financials and some highlights before we open up for your questions. The link to the slide deck can be found on our website, dhtankers.com. Before we get started with today's call, I would like to make the following remarks. A replay of this conference call will be available at our website, dhtankers.com, until May 17.\n\nIn addition, our earnings press release will be available on our website and on the SEC EDGAR system as an exhibit to our Form 6-K. As a reminder, on this conference call, we will discuss matters that are forward-looking in nature. These forward-looking statements are based on our current expectations about future events, as details in our financial report. Actual results may differ materially from the expectations reflected in these forward-looking statements.\n\nWe urge you to read our periodic reports available on our website and on the SEC EDGAR system including the risk factors in these reports for more information regarding risks that we face. The company continues to show a very healthy and strong balance sheet, and the quarter ended with $58.7 million of cash. At quarter end, the company's availability under both revolving credit facilities was $176.8 million, putting total liquidity at $235 million as of March 31. Financial leverage is about 30% based on market values for the ships.\n\nAnd net debt per vessel was $17.8 million at quarter end, which is well below current scrap values. Looking at the P&L highlights. EBITDA for the quarter was $14.4 million and net loss came in at $17.3 million. The result includes a noncash gain in fair value related to interest rate derivatives of $7.5 million.\n\nThe company continues to show a very good cost control, with opex for the quarter at $18.3 million equal to $7,800 per day per ship. G&A for the quarter was $6.8 million, and includes non-recurring accruals related the retirement of the previous co-CEO. In the first quarter of 2022, the company achieved an average TCE of $17,100 per day. For the second quarter of 2022, 69% of the available days have been booked at an average rate of $24,800 per day and 59% of available spot days have been booked at an average rate of $19,900 per day.\n\nOn the next slide, we present the cash bridge for the quarter. We started the year with $60.7 million of cash, and we generated $14.4 million in EBITDA. Ordinary debt repayment and cash interest amounted to $7.2 million of $3.3 million was allocated to shareholders through dividend payment. And $2.3 million was used for maintenance capex.\n\nChanges in working capital amounted to $4.5 million, and we ended the quarter with $58.6 million of cash. As you will note, and despite the very challenging freight market, we did not burn any cash. Switching now to capital allocation. The company will pay a dividend of $0.02 per share for the quarter.\n\nIt will be payable on the 26 of May to shareholders of record as of 19 of May. This marks the 49th consecutive quarterly cash dividend. For the three remaining quarters of 2022, we estimate cash G&A of $3.3 million and noncash G&A of $0.8 million in average per quarter. Following the sale of DHT Hawk and DHT Falcon, depreciation for the three remaining quarters of 2022 is estimated at about $31.5 million on average per quarter.\n\nOur subscribers will be fully depreciated at the end of 2022. We expect annual depreciation for 2023 to be about $100 million. With that, I'll turn the call over to Svein.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThanks, Laila. We have entered into agreement to sell the DHT Hawk and the DHT Falcon with deliveries set to take place during the second quarter. Price is $78 million for the payer and compares favorably to the combined price of $98 million that we paid for them some eight years ago. The sales are expected to generate some $12 million in combined profit, and we will repay the remaining outstanding debt on the vessels amounting to about $13 million in total.\n\nFollowing these sales, the average HR fleet will be reduced on our AER and EEOI metrics improved. On this slide, you will find an update of our cash breakeven levels for the remainder of the year. As per usual, all true cash costs are included in our presentation, i.e., opex, debt amortization, interest, G&A and maintenance capex. The numbers are best-in-class with a required rate of $15,100 per day for the fleet as a whole, and importantly, $8,500 per day for the spot ships specifically in order for the company to be cash neutral for the remaining three quarters of 2022.\n\nOn this next slide, we wanted to share an observation of the peer group within large tankers. As you will see, there is a distinct change in the development of financial leverage within this group. DHT is represented by the green line and the lowest financial leverage. As you will recall during the last upturn, not only did we return significant money to shareholders through quarterly cash dividends, but we also invested in the balance sheet and reduced interest-bearing debt by about 50%.\n\nDespite the recent tough markets, we have retained our balance sheet strength. And you could also note that we have no newbuilding capex commitments. Your takeaway here should simply be that DST has the strongest balance sheet in the group. I'll now offer some commentary on the market.\n\nWe believe a market recovery to be underway, but delayed and troubled by COVID in China and geopolitics generally impacting macroeconomics. Admittedly, and given all the noise, it is very difficult to predict the near-term freight markets. But trying to look through all this noise, we see fundamentals developing toward what we expect to become a rewarding market for large tankers. Oil inventories are low and are now likely more pronounced as energy security is increasingly becoming an issue.\n\nOPEC is so far sticking to its plan, but with underperformance by the respective membership quotas. The merger talk about Iran deal takes longer than market observers have suggested. And the Russia-Ukraine conflict is reducing supply. The U.S.\n\nhave however announced release from the SBRs, a release that will offer the market a double benefit. Firstly, through additional barrels to the market over the coming six months and then likely refill in due course. Further, we don't think it's unreasonable to expect Saudi and the UAE led OPEC response to higher oil prices at some point, maybe in the second half of this year. As you all know, ship owners make a living by transporting supply and the danger of talking our own book and stating the obvious, more supply will be most welcome.\n\nThe sanctions and ensuing trade disruptions coming out of the Russia-Ukraine conflict seems to be increasing transportation distances. So far most visible to ship smaller than the VLCCs. If freight differentials become too wide, freight tend to flow up and down between the different ship sizes. We saw some of this at the outset of the conflict and should the regulator trades see these differentials come back the theory that the tide lifts of boats could hold true.\n\nThe pop in freight rates for VLCCs that you saw a few weeks back is a good indicator that the underlying balance is not as bad as the current rates are indicating. Keep in mind that VLCCs typically transport almost 45% of all seaborne crude oil volumes with closer to 60% on a ton mile basis. This is truly the workforce of the oil industry. The trade disruptions are changing sourcing of refined oil products, elevating freight rates for product tankers.\n\nAs this happens at the time of low inventories of both crude oil and refined products, it begs the question whether product tankers are front-running crude tankers suggesting demand for feedstock and thus crude oil transportation to [Inaudible]. There are currently too many ships in the market. The world fleet is, however, getting older by the day in combination with low ordering of new ships. The VLCC order book consists now of 54 ships to be delivered through the remainder of this year and next.\n\nThis equals a mega 6.3% of the existing fleet, very low by any reference. With very limited scrapping, the current number of ships over than 20 years has now become significant. This part of the fleet could grow close to 100 ships by the end of the year, assuming no scrapping. We find it discouraging those older ships are not retiring from the fleet, in particular, with very healthy demolition prices being offered.\n\nUntil not long ago, there were hardly any commercial prospects for ships older than 20 years. But sadly, it is only sanctioned trades that keep all these older ships currently in business. These sanctions have simply developed new trades for ships that do not comply with rules and regulations. We do think, however, that something's got to give as dry docks and other capital expenditure eventually will force all the ships out of the market.\n\nSo in sum, all this would lead us to envisage the fleet to potentially shrink at the time when demand for transportation is expected to recover, creating a very rewarding freight environment. It would be a very bold move to bid against large tankers. And with that, we open up for Q&A.\n\nOperator\n\nThank you. [Operator instructions] Your first question comes from the line of Jon Chappell from Evercore ISI. Please ask your question.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nThank you. Good afternoon and good morning. I am going to ask all my questions in kind of one multiparter. The vessel sales make 100% sense given the asset values also given where equities are trading right now and you didn't have much debt on them.\n\nSo the first part is, what's the use of proceeds from that net $65 million? And then secondly, you've kind of indicated in the past that you're not interested in buying assets at this point. And again, if you're selling, then the prices would probably indicate you're not into buying. If we are in the beginning of this upturn, as you've laid out, you're probably not going to have other opportunities to buy either. So do you kind of envision the next several quarters, the next beginning of the upturn in the cycle to be a kind of cash harvesting period and with more aggressive capital returns to shareholders and then look to purchase when we're kind of peaked or past the cycle?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThank you, Jon. Just to be clear, we didn't say that we were not interested in buying at this time, but we have not been interested in buying at some of the prices that people have been asking. So there is a sort of reasonable distinction in those two observations. So we are always sort of looking at opportunities.\n\nAnd it's been really hard. We think to find something that has made good sense, but we should not really rule that out. And I think with our balance sheet, we are more than able to fund any acquisitions that we sort of would like to look at without relying on additional capital. So if we do something, it will certainly sort of improve the earnings in the company.\n\nBut as you also noted, we do like to have a sort of low leverage balance sheet. We think our business is sort of suited for that. So the balance sheet is on for the business. It depends on which way you look at it.\n\nAnd as you also point to when it comes to capital allocation, our policy is a minimum 60% of ordinary net income. And we have demonstrated in the past that when sort of earnings or cash flows are [Inaudible]. We have certainly rewarded shareholders with more than 60%. So that's also possible.\n\nAnd of course, with sort of low cash breakeven, low leverage over time, it could put the company in position to be more generous than not the specific numbers suggest that sort of we will not be drawn on giving you a specific outcome on that. But that's how we sort of think about it in general.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nAnd I lied before, I do have one more additional question. It seems like other segments have been more immediate direct beneficiaries of some of the new trading routes developing from what's happening in Europe right now. Are the VLCCs just a laggard in that regard? Or do you see maybe China comes back online, reverse lightering from the Baltic or the Black Sea that could be a big VLCC beneficiary? How do you kind of see the map redrawing to the benefit or not of the VLCC market over time?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nYes. Prior to the conflict, you had some four to five VLCC cargoes going out of the Baltic and ever all loaded two shipments in the Danish straights. So that business, of course, will become very difficult for most people. And from what we understand also, the niche pilots are not so interested in assisting that type of [Inaudible] 00:16:52 shipment to take place.\n\nSo people are sort of further away to try to do this. But currently, it's really some of the traders buying this oil, and it's not a business that we touch. But I think it is -- this whole conflict situation changes, one should expect that trade to come back at some point. This has not really been the case out of the Black Sea, where you have more sort of Suezmax is trading directly out to Asia.\n\nWhat we did see immediately after the conflict, we had some B2C loading south of the U.S. Gulf going to Europe. And with multiple port discharges so two to three discharge ports in the Iberian Peninsula, etc. So that -- and those were done at very good freight rates up in the $40,000 a day sort of territory.\n\nSo that might well sort of increase at some point once these U.S. barrels are coming to market. There seems to be appetite for, in particular, the light crude in Europe. So which is driving a lot of West African barrels now going to Europe.\n\nSo there are so many moving parts here, and it's very hard to have a precise view on exactly how it will play out other than just saying that disruptions and increased distances will serve our business well. And I do think right now, we are probably the last ship type to benefit from this. But eventually, it will also come to the VLCCs and then it should be quite forceful we think so.\n\nJon Chappell -- Evercore ISI -- Analyst\n\nOK. That's very helpful. Thank you.\n\nOperator\n\nThank you. Your next question comes from the line of Chris Robertson from Jefferies. Please ask your question.\n\nChris Robertson -- Jefferies -- Analyst\n\nOh, it's fine. Thank you for taking my questions. Yes, you guys have done a good job in the past with countercyclical investing and divesting. So you have a handful of ships with the same age profile as the two that were just sold.\n\nCould we see some additional vessel sales this year? Or do you think that's over with at this point?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nIf we see sort of these that we think are attractive to divest, say, one or two more ships that that could certainly happen. So the challenging part also in sort of selling ships in this age bracket is that they are not all buyers that a company like DHT can entertain to the business with. So on this occasion, this was a known entity to us. Somebody who have done business with in the past, and they've performed very well and it's a proper company.\n\nSo for us, that sort of worked out and that in connection also with a good price. So I will not rule it out, but it's not like a heavy marketing or effort in sort of getting rid of ships. We have a high-quality fleet and they're also ready to that once the music can really start.\n\nChris Robertson -- Jefferies -- Analyst\n\nSure. I guess just thinking about the pre-eco built ships, especially the pre-2010. What's the incremental capex needed to bring them up to speed for IMO 2023 and beyond? And does it vary heavily by age bracket? Or is it about the same price?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nI think for all those ships, they have large engines, and we've gone through the exercise of calculating sort of the EXI and what we then would need to do with the ships. There will be some minor sort of power reductions. But the power reductions ends up in sort of cap speeds, which are still way higher than what is the service speed in the market. So basically, all these ships are designed to run at 17.5 -- 18 knots.\n\nAnd we might have to cap speed that's, call it, 15.5 knots or maybe closer to 16 knots. Whereas the service speed in the market is 13 knots and 13.5 knots. So I think commercially, we'll have hardly any, maybe on the limited impact on DHT's earnings capability. And there's not any capex to speak of to.\n\nThis is really a pocket money, so.\n\nChris Robertson -- Jefferies -- Analyst\n\nGreat. Yeah. Thanks for that color. That's all for me.\n\nThank you.\n\nOperator\n\nThank you. Your next question comes from the line of Frode Morkedal from Clarkson Securities. Please ask your question.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nYes. Thank you. A few questions on this vessel sale you did. Looks like a very good price you achieved.\n\nI guess, did -- and they, of course, include the scrubbers, right? So one question I had is did the value of the scrubbers come up in the discussions? And if so, how much would you ascribe this scrubber value to be in today's market?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nAnd there was no specific discussions about the scrubber value. This buyer wanted ships with scrubbers. So it was not sort of an alternative discussion. So do you have ships without scrubber and what is the price differential.\n\nSo it was sort of very straightforward. And we had a sort of rough idea what we wanted for the ships, and they were able to -- willing to meet our price expectations. So there's been some volatility in the spreads. It's been sort of a $100 and been up to $250.\n\nSo it depends what you put in the thing for sort of ease of reference at the $100 spread, then the nominal value in the year on a ship for this vintage is in the sort of $1.5 million to $1.7 million incremental earnings. So then you need to have a view on how long you think these spreads will stay. So but as I said again, there was no specific discussions on a value per se so.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nNow the reason I ask is that if you look at the, let's say, broker quote, they usually do not -- well, it's scrubber free value typically.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nYes. That's correct.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nYes. In general terms, how do you see the sale and purchase market for VLCCs today? And in combination with that, can you also talk about the timing of this investment sale? I guess, given the outlook you have, which seems to be quite optimistic, would vessel prices move even higher in the future? Or do you think like there's the new carbon regulation that's coming into play next year have an impact for these older less?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThere seem to be a reasonable liquidity in the older end. But as I mentioned on the prior question, it's not all these counterparties that we could do business with. So they might work out for a private buyer, so to say. So but there are sort of regular transactions happening in that space.\n\nAnd for older ships, they are trading anywhere depending on the age and the condition from sort of the high 20s up to sort of the high 30s, as we now or maybe even 40s as we now demonstrated. So it depends on their value position, ballast water treatment, scrubbers, prior history, etc. But there are sort of regular transactions taking place. In the sort of very modern end, there are a few things being talked around and one can do something if one wants to.\n\nBut it seems to sort of be a bit, I would say, sideways as there are not many transactions taking place and not that many players. So there's not some real big movement and it's a bit disconnect from new building prices. And I think the reason for this is that the asking price from the shipyards at 120 plus/minus is just a derivative of what they can get for a gas carrier, LNG carrier or a large container ship. So it's not really driven by strong demand to both tankers.\n\nSo and that's really great news for our space because you don't really see a lot of people waiting in on building large factors now so that we just a great benefit. And so in the middle bracket call it ships around 10-year mark, they are very -- not that many transactions taking place, not much for sale or purchase. So you have to sort of move over to sort of starting at 13, 14 years old ships before you see much movement. So that also been a bit sideways, I would say.\n\nAnd again, here, it depends very much on the specific ship yard to build that, how it's equipped, etc. But some of the private owners are sort of keen to venture in that area. And I understand why they do that. It doesn't sort of offer any fuel economic benefits compared to eco-ship, but it is nevertheless some quality ships in those vintages in the market, and they will also have a reasonable time, I think, in a market recovery.\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nYeah. Sure. Thank you for the color. That does it for me.\n\nOperator\n\nYour next question comes from the line of Robert Silvera from Associate Marine. Please ask your question.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nIt's a very good job as usual. You guys are conservative and have reduced your interest cost, which is always positive. You did have extra shares outstanding of about $672,000 plus. And I was curious where those shares went? Were they in fulfillment of option buying? Or where did they come into existence for?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nSo the company on a regular basis has a long-term sort of incentive program for directors and officers. And there are sort of allocated shares that could be rewarded on a typically rewarded annually with vesting criteria. So that is a reflection of that.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nOK. So it's all management then directors and management?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nCorrect.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nYou also note a number of calls and you call it the share of profits from associated companies. Can you give us some color on what that is?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nYes. So we own -- in the first quarter, we own 50% of our ship management company, Goodwood in Singapore that runs all our ships, not an associated company. We have now subsequent in the second quarter, increased our ownership position to have our economic control of the company and also have two or three directors of that company so increasing our position. So we will change the accounting treatment of that company going forward.\n\nBut that will be visible from the second quarter results onwards.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nOK. But that will increase profits. So can you?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThe company is profitable, but the change in ownership from 50% to 53% is not significant in sort of nominal sense. So it's a small part of the P&L in DHT.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nIn one of the earliest questions, there was a cash from the sale of the ships. What was your allocation for it. And I missed -- I didn't pick up what your answer was on that. What did you -- what are you using that -- those millions for?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nSo initially, the cash flow going to the company's sort of cash reserves. We have not communicated a specific use of that cash. We are sniffing around if we can find a good investment opportunity, although we must admit they're very hard to find right now. So that is one alternative.\n\nAnd we could also do, as we have done in the past, is to prepay more debt. So that's also an opportunity that we have. And I think in the next quarter or two, that will become more visible to investors as we move ahead and to see what we have decided to do, could also, of course, be a mix of both, so.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nYes. I like the alternative of reducing the debt. That's always a good one in my mind. One last question.\n\nThe large number of ships that are over 20 years and stuff, how is that playing right now with the scrap steel market? Is the scrap steel market still high and attractive to take these ships out? Or has it been dropping?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nWell, the prices to sell the script for the ship for demolition is still very high, which all makes it a bit puzzling that you don't see more ships heading for the crap yards. So but as I mentioned, it's really driven by the fact that they have some commercial opportunities that are almost sort of exclusively available to people willing to take these risks and not be compliant. So these sanctions have, over time, created sort of a separate market. And you could be -- maybe you can be concerned that for the smaller ships like Alfa, etc., that if Russian cargoes also are sanctioned, you could create an additional pocket for similar types of businesses in the future.\n\nSo it's not an ideal outcome. It's the flip side of sanctions, which we understand why they are being made. But unfortunately, IMO and the relevant flag based are not able to reinforce these regulations and get rid of the ships so.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nWith your experience though, with the ship ages that are out there, when do you see it kind of being economically forced that they be scrapped a year out, two years out?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nWith the new regulations coming on from 2023, I think the next sort of hard line will be 2026. And I think by that time, it's going to be very, very difficult, if not impossible to operate older ships. And if you look at sort of the demographics of the fleet, you will note that our ships will sort of move out of the commercial picture well within that time. So we have sort of a natural retirement either by selling or also potentially scrapping in due course.\n\nSo we will sort of pass through that. And what we will own beyond that will be a very efficient fleet, assuming nothing else happens.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nRight. Well, thank you. Thank you very much for doing such a good job.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThank you for supporting.\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nThat's it for me. Thank you. Yeah.\u00a0\u00a0\n\nOperator\n\nYour next question comes from the line of Clement Mullins from Value Investor Research. Your line is open. Please ask your question. As there is no answer, I'll move on to the next question.\n\nThis question comes from the line of Chris Tsung from Webber Research. Please ask your question.\n\nChris Tsung -- Webber Research -- Analyst\n\nHi. Good afternoon. Thanks for the question. I wanted to ask about just all the good ones were taken already.\n\nSo just moving on to the dry docking schedule. I think there's one left for the second half of this year. I know in 2021, in light of a soft freight market you guys pushed up several trade docking. Is there -- do you guys have that slogan available if just for the rest of the year? Or it's just one that most you could be?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nThere's only one ship left for this year. We might start with one that's due in January later this year. But if you want details, please make contact with our CFO, Lila, and she will assist you with more details, so.\n\nChris Tsung -- Webber Research -- Analyst\n\nOK. Great. And just on the vessel sales, it looks like the outstanding debt on the two were about $13 million, given the DHT financing, $2.5 million over the Romania economic play. That, to me, comes out to be about two to 2.5 years remaining on these vessels.\n\nSo is it right -- am I thinking about it correctly that the economic life that you guys built in is about 18 years for these VLCCs?\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nNo. What we do with finance is that we like to cap the borrowing ownership to be maximum $2.5 million per year in amortization for the remaining commercial life of that vessel. So for a new building for 20 years life, it will be $50 million sort of maximum debt. If you buy a 10-year old shape, it will be $25 million.\n\nBut it's also a reflection here that we have done some prepayments on that earlier on. So there's a mix of sort of regular amortization and some prepayments and the debt was a bit lower, so.\n\nChris Tsung -- Webber Research -- Analyst\n\nOK. All right. That's it for me. Thank you.\n\nOperator\n\n[Operator instructions] There seems to be no further questions. Please continue.\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nWell, thank you very much to everyone for listening in on DHT and your support and interest in our company. It's most appreciated. Wish you a good day ahead.\n\nOperator\n\n[Operator signoff]\n\nDuration: 38 minutes\n\nLaila Halvorsen -- Chief Financial Officer\n\nSvein Harfjeld -- Co-Chief Executive Officer\n\nJon Chappell -- Evercore ISI -- Analyst\n\nChris Robertson -- Jefferies -- Analyst\n\nFrode Morkedal -- Clarksons Platou Securities -- Analyst\n\nRobert Silvera -- R.E. Silvera and Associates -- Analyst\n\nChris Tsung -- Webber Research -- Analyst\n\nMore DHT analysis\n\nAll earnings call transcripts"}
{"id": "00e1f179-90d4-4d25-be0d-50b1a808041a", "companyName": "FiscalNote Holdings, Inc.", "companyTicker": "NOTE", "quarter": 3, "fiscalYear": 2022, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/11/14/fiscalnote-holdings-inc-note-q3-2022-earnings-call/", "content": "FiscalNote Holdings, Inc.\u00a0(NOTE 2.87%)\nQ3\u00a02022 Earnings Call\nNov 14, 2022, 10:00 a.m. ET\n\nOperator\n\n[Operator instructions] Sara Buda, vice president of investor relations, you may begin your conference.\n\nSara Buda -- Vice President, Investor Relations\n\nThank you, operator, and welcome, everyone. During this call, we may make certain statements related to our business that are forward-looking statements under federal securities laws. These statements are not guarantees of future performance but rather are subject to a variety of risks and uncertainties. Our actual results could differ materially from expectations reflected in any forward-looking statements.\n\nFor a discussion of the material risks and other important factors that could affect our actual results, please refer to our SEC filings available on the SEC's EDGAR system and our website, as well as the risks and other important factors discussed in today's earnings press release. Additionally, non-GAAP financial measures and other KPIs will be discussed on this conference call. Please refer to the tables in our earnings release for a reconciliation of non-GAAP measures to their most directly comparable GAAP financial measure. With that, I'd like to turn the call over to FiscalNote's chairman, CEO, and co-founder, Tim Hwang.\n\nTim Hwang -- Founder and Chief Executive Officer\n\nThank you, Sara. I'm glad to be here today on our Q3 2022 earnings call, which marks our second earnings call as a public company. Today, I'm going to provide some insight on our mission as a company and the unparalleled value we deliver to our commercial and public sector customers every day, cover a brief summary of our quarterly results, and discuss the foundation we have in place today in our strategy to leverage our unparalleled market leadership to deliver consistent, ongoing, profitable, compounding growth in the long term. Then, I'll turn it over to Jon Slabaugh, our chief financial officer, to discuss the details of our results and our outlook for year-end.\n\nBecause many of you are new to the FiscalNote story, let me start with a brief reminder of who we are and the long-term vision of the company. At FiscalNote, we're on a mission to help our customers make sense of the complicated political and regulatory world we live in by building fast technology products that help aggregate and organize government information and understand the impact of public policies on their organizations. Changes in laws and regulations impact the decision-making of almost every organization around the world, from changes in a complicated tax code, to operational changes companies and organizations must make on an ongoing basis. FiscalNote's products help to make sense of the changing regulatory and legal obligations by aggregating vast amounts of information and serving it to them on a regular basis, along with proprietary analysis, using cutting-edge machine learning and AI capabilities.\n\nAs such, we're building an enduring and durable company for the world's most important decision-makers, ranging from hundreds of government agencies from the White House to the CDC, to half the Fortune 100. These organizations rely on FiscalNote every single day to help interpret the impact of policies, laws, and regulations to their institutions. We power decision-makers in the areas of international diplomacy, foreign direct investments, trade policy, political strategy, and everything in between. Since we founded the company 10 years ago, we have been building a disruptive category creator, which constantly innovates to turn insights into actions and convert challenges into opportunities.\n\nIn a sense, we've become an increasingly mission-critical and ubiquitous Bloomberg Terminal of political, legal, legislative, and regulatory information at the local, state, federal, and global levels. This is a tremendously important time for our customers because the insights and answers we bring have a direct positive impact on their operations, risk management, and business strategy. From geopolitical conflicts in a country where they store supplies, to changing labor policies and wage regulations in states where they employ talents, to local sustainability regulations in municipality they operate in, the regulatory and policy environment changes constantly at all levels of government. Traditionally, making sense of all this information has been a manual and opaque process, and remains a massive underserved opportunity.\n\nOnly FiscalNote has the breadth of data and information and the depth of proprietary AI cloud-based workflow software and analysis to make sense of this exploding volume of dynamic, unstructured data and information. As a result, more than 5,000 global customers in the commercial and public sectors depend on FiscalNote SaaS platforms and analysis to discover, process, and navigate the impact of government policymaking on their organizations and, more importantly, to take actions, which achieve their business objectives. FiscalNote steady and long-term compounding growth arise from a consistent need by organizations to respond to trigger events, ranging from a new change in congressional leadership as part of an election, rule changes at a regulatory agency, or a new court case that may change the requirements of organizations around the country. Given the myriad of political challenges that exist, we believe FiscalNote is well positioned to be a primary beneficiary of this policy complexity.\n\nIn FiscalNote's approach to building a long-term growth compounder, we believe that there are two key components required to drive our strategy: number one, continue our strategy for growth and customer acquisition and product development to increase our customer base and deepen our relationship with our customers; and number two, driving efficiency in our operations to drive sustainable, profitable growth in the future. First, on growth. You saw from today's press release, we recently secured new commercial logos and expanded key accounts, including many Fortune 100 enterprise customers across a wide range of industries and geographies. A few weeks ago, we also announced several new contract wins, expansions, and renewals for our public sector clients across the executive, legislative, and judicial branches of the United States government.\n\nTogether, they serve as breakthrough points about the value we bring and the enduring and expanding nature of our relationships. Additionally, we previously announced major enhancements to our European product lines and key integrations with companies like Asana for our ESG product line that provide new avenues for growth in both geographic and subject matter areas for FiscalNote. As part of our continued geographic expansion, we announced the acquisition of DT Global that gave us an expanding and great breadth of information and content in Eastern Europe and the Middle East, particularly as the attention of the world turns in that direction. Every day, we provide the world's most important decision-makers with information, fast workable tools, and expertise they need to navigate an increasingly complex, volatile, and unpredictable geopolitical environment.\n\nI'm immensely proud of our teams and the critical work we do. Second, in our drive to deliver sustainable, profitable growth into the future, for the past 12 quarters, FiscalNote has continued to make investments in areas of artificial intelligence, automation, and technology to drive a more sustainable rate of growth. We've also reduced our cost to serve by expanding our scalable service model, consolidating frontline management, standardizing operations, refining KPIs for effective performance management, and shifting select customer support staff to lower cost geographies. That gives you a sense of what we do and the importance of the solutions for our customers.\n\nI'd also like to talk to you about who we are as a company and how we are building an enduring and resilient market leader of the future. We're doing that by providing a SaaS-based information platform, which helps solve critical information challenges specific to legal policy and economic data, building a broad and diverse base of recurring revenue with global customers across public and private sectors, and deploying a capital allocation strategy and operation model, which could drive long-term sustainable growth. We are undeniably a company focused on being a long-term growth compounder. Our growth strategy is simple: renew our base of customers every year, cross-sell and upsell new solutions, and build on this platform to address truly transformative categories in the future.\n\nOur listing this year was an important milestone for FiscalNote. And now, we turn our attention to sustainable growth through smart capital allocation. As leaders, we, along with Josh Resnik, our president and chief operating officer; and Jon Slabaugh, our chief financial officer, spent an extraordinary amount of time focused on capital management strategies, which support our foundational growth to be an enduring, profitable leader in our sector. As such, as a team, we will never choose a growth-at-any-cost strategy.\n\nWe are building this business for the long term. And the decisions we make will always be driven by our unrelenting focus on fundamental, sustainable profitability and cash flow in the long term. With that in mind, as a reminder, FiscalNote has always been differentiated, given not only its recurring revenue base, but also its high gross margins. These gross margins, results of our business model and software and data products, provide the basis of strong cash flow in the future.\n\nAs we evaluate capital allocation strategies, we balance the goal of minimizing dilution for existing shareholders while optimizing return in our internal investments across product and sales, as well as in future acquisitions. The combination of a recurring revenue business model, a high gross margin that provides the foundation for increasing profitability, and a management team focused on driving the highest return on capital, both organically and organically, means we are laser-focused on delivering long-term shareholder value through our decision-making. With this backdrop, let me give you a brief summary of our third quarter financials. As you saw in the press release, we delivered GAAP revenue of 29 million for the quarter, marking growth of 34% year over year.\n\nOur Q3 adjusted EBITDA is at negative 7.4 million, on track with internal plans. We are reiterating our adjusted EBITDA guidance for 2022 and our goal of adjusted EBITDA profitability in Q4 of 2023. Finally, our capital structure positions us well to drive organic and inorganic growth and support our path to profitability. In addition to the standard metrics, which we share in our earnings release, we provide additional information to help you understand our business and our priorities as a management team.\n\nOur three core KPIs are as follows. Run-rate revenue. This is a key management metric and is defined as ARR plus nonsubscription revenue earned during the last 12 months. Run-rate revenue was 121 million as of September 30th.\n\nThis marks growth of 14% year on year, including '21 and '22 acquisitions. Annual recurring revenue. Annual recurring revenue was at 108 million at September 30th, growth of 14% year over year. Net revenue retention.\n\nNet retention continues to be strong at 99% in Q3, consistent with the prior quarter. Our growth remains durable, and our business continues to excel. And this brings me to our guidance. First, we reiterated our adjusted EBITDA expectations for fiscal year 2022.\n\nWe are clearly on path for the near-term profitability goals we've outlined despite macro and market headwinds. Our management team's primary goal is adjusted EBITDA profitability, and that is exactly what we are on track to deliver. This is a continued focus and drive for the business that remains unwavering and unchanged. We have taken a number of initiatives, both structurally and culturally, to drive sustainable and profitable growth into the future, particularly given the environment we all find ourselves in, reprioritizing our commitment to profitability in order to be prudent capital allocators and drive strong returns for our shareholders.\n\nSecond, given our durable net revenue retention rates and the underlying recurring revenue fundamentals of the business, we added GAAP revenue as one of the metrics we will guide to moving forward. Third, we updated our organic run-rate revenue expectations. We expect organic run-rate revenue to be in the range of 122 million to 126 million as of December 31st, as defined in the release. On that, let me provide some perspective.\n\nAs of the end of Q2, we had not seen an adverse impact from changing macroeconomic conditions in our sales efforts. In fact, throughout Q3, we secured a number of new high-profile customers as you saw from today's press release. Late in Q3, however, in September, we began to see some new prospects pause purchase decisions, plus elongating sales cycles, as a result of their own internal budget mandates brought on by the uncertainty of the macroeconomic forecasts. To be clear, new business was still strong in the quarter, just didn't come at the levels we initially forecasted due to the change in the macro environment.\n\nThat said, our year-over-year ARR growth remained strong, and our in-quarter net revenue retention rate is 99%. This demonstrates our customers rely on FiscalNote's must-have solutions to address existential issues now more than ever. We feel confident that we will continue to secure new business and grow relationships with our existing customers, given the importance of our products, as we have done for almost 10 years. By way of example, currently, customers are signing on or growing with us so that they can leverage our platforms to manage their existential issues they face from political, economic, and security risks.\n\nAs an example, businesses with supply chains impacted by turmoil in Eastern Europe; find incremental revenue opportunities by identifying and assessing new businesses, such as finding state and local government contracts after bid; and generate operational ROI by handling global compliance need more effectively, scaling their tracking and analysis of the platforms, rather than through manual efforts or internal resources. In sum, we believe we're more recession-resistant than many enterprise SaaS companies due to the stability of our government customer base and a mission-critical solutions we provide to our government and enterprise customers. But no company is completely immune to a more cautious enterprise decision-making cycle that occurs during macroeconomic uncertainty. Moving forward, we do have a number of indicators that indicate continued growth.\n\nFirst, given the critical nature of our solutions for both private sector and public sector organizations, the overall demand remains strong. Second, the business continues to have sound fundamentals, delivering strong net revenue retention and organic ARR growth. Third, in Q4, while still early days, we're starting to see an uptick in business activity as prospects gain clarity in their budgets that many of them did not see before. That said, the time to close new business is clearly elongated in this environment, and we are being prudent in our forecast.\n\nWhile we are not giving '23 guidance today, based on current activity, we expect to see fundamentals hold up, as we drive sustainable mid-teens organic growth year over year. In short, our compounding growth remain strong. Our GAAP revenue year-over-year growth of 34% this quarter demonstrates continued growth. With underlying ARR and a rich pipeline of new business, we are well positioned to drive ongoing organic growth.\n\nIn addition to organic growth, as a company, we continue to actively pursue accretive value-add acquisition, which provide cross-sell and upsell opportunities, which, in turn, form incremental growth opportunities in new customer segments and geographies. We have a strong and proven track record of accretive acquisitions which support our organic growth. As of today, our acquisition pipeline remains active. We are, however, being thoughtful as we pursue accretive acquisition and valuations aligned with the fundamentals of the business and the macro environment we're operating in today.\n\nAs I said, we are prudent capital allocators, and we'll always be judicious to prioritize investments that drive the highest return for our shareholders. In that spirit, before I turn over to Jon, let me summarize a few key points about FiscalNote and our strategy. We are a long-term growth compounder with a diverse and broad recurring revenue base of customers, which we renew and expand each year, which creates the foundation of an enduring and durable business in the long term. With a proven operational delivery model and a competitive moat based on the breadth of data analytics and insights we built over the past 10 years and the depth of our proprietary AI and SaaS workflows, we believe FiscalNote is well positioned to be a primary beneficiary of global policy complexity, given the myriad of political challenges that exist.\n\nWe are led by a disciplined, experienced, and exceptionally talented team with a relentless focus on sustainable, profitable growth, and smart capital allocation to build an enduring company for the future. Moving forward, we see several catalysts that will enable us to outperform over the long term. We will drive incremental growth and new value for our customers with additional data sets, insights and solutions, and workflows, giving us an expanding TAM and runway for growth in the mid to long term. We will add new investments in soft workflows, particularly in solutions, that allow us to enter new, transformative, regulated sectors in the future.\n\nWe will continue to make growth investments in Europe and APAC. We are tremendously early in our growth maturity. And we will meet our near-term and long-term profitability targets. In doing so, we ultimately lower cost of capital, which allows us to continue to build an enduring growth company and accelerate our market leadership position.\n\nThank you for your time. And with that, I'll hand it over to Jon Slabaugh, our chief financial officer and chief investment officer.\n\nJon Slabaugh -- Chief Financial Officer\n\nThank you, Tim, and good morning, everyone. I'd like to start off by providing more detail around the substantial progress we've made this quarter as we deliver on our profitability goals and further our strategy for becoming a long-term compounding growth company. Let me start off with revenue. For the third quarter, GAAP revenue was $29.1 million, up 34% year over year.\n\nYear-to-date revenue through September 30th was $82.3 million, marking over 40% growth from the same period last year. On an organic basis, our GAAP revenue growth rate was 13% year over year for Q3 and 14% year to date. What this states is very clear. Our underlying growth remains strong, and our M&A strategy is playing out largely as we expected, adding scale and giving us cross-sell and upsell opportunities to build on our compounding growth model.\n\nSubscription revenue, which makes up approximately 90% of our total revenue, was $26.1 million, an increase of $5.9 million or 30% from a year ago. Our advisory, advertising, and other revenue was $3 million in the quarter, an increase of $1.4 million from a year ago. As Tim mentioned, run-rate revenue is a key management metric defined as ARR plus nonsubscription revenue earned during the last 12 months. FiscalNote's run-rate revenue exiting September was $121 million, an increase of $15 million or 14% versus last year on a pro forma basis.\n\nOn an organic basis, run-rate revenue was $120 million as of September 30, 2022, including the Aicel acquisition but excluding other businesses acquired in 2022, also reflecting a 14% year-on-year growth rate. Our total annual recurring revenue, or ARR, rose to $108 million in September 30th, an increase of about $13 million or 14% compared to the same period in 2021 on a pro forma basis. Organic ARR also grew 14% year on year on a pro forma basis. Net revenue retention, or NRR, measures FiscalNote's success in retaining and growing our ARR for existing customers.\n\nARR was 99% for the quarter ending September 22, which is largely consistent with the same period in 2021. Our net revenue retention rate does fluctuate depending on the quarter and the sales mix between workflow and information services. Now, let's review some key profitability metrics. Gross profit was $20.4 million in Q3, representing a 70% gross margin.\n\nNon-GAAP adjusted gross profit was $23.3 million in Q3, representing 80% gross margin. To be clear on the difference, adjusted gross profit adjust for deferred revenue and amortization of intangible assets. Gross profit dollars in Q3 increased 25% versus a year ago. Both GAAP and non-GAAP gross margin percentages were down year over year, largely due to certain expense allocations from acquisitions.\n\nMoving forward, we expect non-GAAP gross profit margins to be relatively steady in the 75% to 80% range, barring any unusual items or variances of future acquisitions. Sales and marketing costs were $11.8 million in Q3, a notable increase from $7.5 million a year ago, as we continue to invest in sales and marketing and accounting for incremental sales expenses related to acquisitions. R&D expenses were $5.6 million in Q3, down from $6.4 million a year ago, in part due to increased software capex. Editorial cost in Q3 were $4.2 million compared to $3.8 million in 2021.\n\nG&A expenses were unusual in this period and were significantly impacted by some nonrecurring items, including $28.9 million relating to the accounting treatments of noncash stock-based compensation expense that was triggered as a result of our DSAC transaction. So, total G&A for Q3, inclusive of these charges, was $38.9 million. Excluding these noncash charges, G&A was $10.3 million, an increase of only about $1 million versus a year ago. The operating loss for Q3 2022 was $44.1 million in total.\n\nExcluding the noncash items I just mentioned, the operating loss was $15.5 million for the quarter. Interest expense was also impacted by nonrecurring expenses associated with our public listing in August. Total interest expense was $42.9 million in Q3. This includes a nonrecurring noncash charge of $32.1 million, recognized as interest expense related to the derecognition of beneficial conversion features that were embedded within certain convertible notes.\n\nBased on the Fed's most recent interest rate increase, we expect annual cash interest expense to be approximately $18 million. Offsetting some of this was a noncash gain of approximately $21.6 million related to the mark-to-market of the public and private warrant liabilities the company is required to fair value at each reporting date. Including these noncash nonrecurring items, the net loss for Q3 was $109 million on a GAAP basis. Our adjusted EBITDA for Q3 was a loss of $7.4 million, which excludes these and other noncash items as detailed in the reconciliation we provided.\n\nOur balance sheet remains in great shape with $78 million of cash and cash equivalents as of September 30th. We believe we have sufficient capital to support our growth initiatives and support our path to positive adjusted EBITDA as expected. This brings me to our guidance for 2022. We are reiterating our expectations for an adjusted EBITDA loss of approximately $23 million, which is the midpoint of our range for the full year 2022.\n\nWe are also reiterating our plan to be profitable on an adjusted EBITDA basis in the fourth quarter of 2023, only 12 short months from now. We are managing expenses and have strong recurring revenue base, which positions us well to achieve our profit goals amid uncertain economic environments. On the revenue side, given our underlying recurring nature of our revenue streams and the relatively strong visibility we have into organic growth, we are instituting annual GAAP revenue guidance. GAAP revenue for 2022 is expected to be between $112 million and $114 Million, which would represent about 36% year-on-year growth at the midpoint.\n\nThis growth demonstrates the compounding nature of FiscalNote's business model. In regard to the run-rate revenue guidance we provided in August, as Tim mentioned, we're updating our expectation for organic run-rate revenue to be in the range of $122 million to $126 million for 2022. This is a deviation from our initial guidance due to economic headwinds in the recently corresponding elongated sales cycles we began experiencing in September, particularly on larger new contracts. The sales cycle for our government business remains relatively steady and unchanged.\n\nOur M&A pipeline remains robust. Proprietary relationships and bilateral negotiations continue to be our most productive source of corporate development opportunities. Considering the current macroeconomic conditions, FiscalNote is being even more selective to ensure we find the right targets and the right valuations. Specifically, we are focusing on opportunities that uniquely address our customer's most pressing needs that will drive predictable, sustainable compounding growth.\n\nOur team has walked away from many opportunities this year, where we could not get comfortable with the target value proposition or growth prospects. We've also walked away from transactions where valuation expectations are not fully adjusted to the current market or macroeconomic realities. As Tim said, we are smart capital allocators, and we will always prioritize the strategic acquisitions that drive the highest returns for FiscalNote shareholders. We have proven our ability to make, integrate, and accelerate growth from acquisitions.\n\nM&A is a building block of FiscalNote's long-term growth strategy. Our pipeline is robust, and we will not push to make acquisitions simply to meet a target number. FiscalNote is currently progressing conversations with several attractive acquisition targets that meet our disciplined criteria. I look forward to providing an update on total run-rate revenue, inclusive of acquisitions, in our year-end results.\n\nIn the meantime, despite the macro environment, our ARR remains strong. Our net retention rates remain stable, and we're driving strong sustainable GAAP revenue growth year over year. This underscores the resilience of our business model and the critical nature of the services we provide to our customers. Most importantly, we are on target to our primary goal to achieve adjusted EBITDA profitability in the near term.\n\nIn sum, we are excited by the path in front of us today. We remain confident in our overall compelling growth trajectory. We are executing on our strategy to build a sustainable, profitable growth business that provides mission-critical solutions for the world's most important decision-makers. Moving forward, we will continue to capitalize on our strong position to drive compounding, profitable growth.\n\nAnd we look forward to working with you, our shareholders, as we build an enduring market leader of the future. With that, we will now open the call up to questions. Operator?\n\nOperator\n\n[Operator instructions] And your first question comes from the line of Matt VanVliet from BTIG. Your line is open.\n\nMatt VanVliet -- BTIG -- Analyst\n\nYeah. Good morning. Thanks for taking the question. I guess, first, would love to maybe dig in a little deeper on what you're seeing from some of the macro issues out there.\n\nYou know, I think you mentioned enterprise is maybe a little more impacted. But maybe just dive in, in any particular regions or size of companies, industry verticals that you're seeing continued strength in and, conversely, any you might call out that, you know, might be a little weaker through the end of the year that you're starting to work more aggressively on.\n\nTim Hwang -- Founder and Chief Executive Officer\n\nYeah. Thanks for the question. So, as I mentioned before, the best way to think about our customer base is this portfolio of customers between private sector and public sector customers. So, one of the things that we're looking at right now is, you know, on the public sector side, if there's any potential changes or whatnot to that particular customer segment.\n\nAnd as you mentioned before, we have not seen any particular changes there. That's largely due to the fact that, on the public sector side, you see a number of customers that are just really in line with congressional preparation cycles or public sectors, RFP processes, and the like. That segment of our business continues to chug along as we've seen in the past. On the enterprise side, you know, that is really where we see some of the potential macroeconomic impacts.\n\nAnd it's really not a particular sector, particular industry, and particular geography. It's fairly broad-based. And I think a lot of that just has to do with the fact that, you know, particularly, as I mentioned before, in September of this year, there's just a lot of noise that people are kind of seeing in the market, whether it was around inflation or labor changes or, you know, kind of changes around the interest rate environment and whatnot. And so, my -- our supposition was effectively that, you know, many of these companies were sitting there trying to make assessments around their P&L through the end of the year and that -- effectively elongated cycles.\n\nThat being said, I mean, we did, of course, book a number of new customers. And one of the biggest indicators, of course, is whether or not, you know, renewals continue to come in, you know, month over month or quarter over quarter. And that has continued to stay fairly stable. And that, obviously, kind of gives us a lot of confidence in terms of our business strategy moving forward.\n\nMatt VanVliet -- BTIG -- Analyst\n\nAnd then, on that front from a sales capacity side of things, you know, I guess, where do you feel like -- if things are slowing, even to a small extent, and seeing your targets for the end of the year, you know, where do you feel like you're at from a sales capacity side and an overall execution side, both into the end of the year and maybe in early '23 plans? You know, is there a lot of hiring that still needs to be done? Or is it a matter of kind of getting the deals that are in the pipeline books with the team you have in place? Thanks.\n\nJosh Resnick -- President and Chief Operating Officer\n\nSure. Hi, this is Josh Resnick, president and COO. I can address that. We actually feel pretty comfortable from a sales capacity standpoint.\n\nWe've invested in building out our sales teams over the course of the year and feel that we're well positioned to capture business, both from a new logo perspective and a renewal perspective, as we head into the new year.\n\nMatt VanVliet -- BTIG -- Analyst\n\nAll right. Good. Thank you.\n\nOperator\n\nYour next question comes from the line of Mike Latimore from Northland Capital Markets. Your line is open.\n\nMike Latimore -- Northland Securities -- Analyst\n\nGreat. Thank you. Yeah. Great to see the EBITDA reiteration here.\n\nI guess as I look to the fourth quarter, I think your EBITDA guidance implies a fourth quarter EBITDA improvement by a few million dollars. Can you just talk a little bit about the levers there to get to that goal?\n\nJon Slabaugh -- Chief Financial Officer\n\nSure, Mike. Thanks for the question. It's Jon. And in terms of the leverage, first of all, we have a great deal of visibility into the GAAP revenue recognized.\n\nSo, we know our pacing to the end of the year. And we've taken all the measures necessary from an operating standpoint to look at the expenses that we're in control of and make sure that they're in line with that level of revenue. So, it's -- we have a fair amount of visibility into it and feel confident in reiterating that number.\n\nMike Latimore -- Northland Securities -- Analyst\n\nYeah. And then, in terms of --\n\nJon Slabaugh -- Chief Financial Officer\n\nI'm sorry. Go ahead.\n\nMike Latimore -- Northland Securities -- Analyst\n\nYeah. So, basically just sort of blocking and tackling on the opex side of things, it sounds like?\n\nJon Slabaugh -- Chief Financial Officer\n\nThat's right.\n\nMike Latimore -- Northland Securities -- Analyst\n\nOK. And then in terms of the acquisition targets, can you talk a little bit about your valuation expectations, what you've been seeing? Do things loosen up next year, do you think?\n\nTim Hwang -- Founder and Chief Executive Officer\n\nWell, so, I can get started, and I'll past it over to Jon here. So, one of the things that we've been seeing, obviously, from an M&A perspective is that many, many companies have become more actionable in the past couple of months. That's due to a number of different factors. The first is primarily because, you know, in many portions of the capital markets, capital is effectively frozen up.\n\nAnd so, there's obviously a limited number of options for a number of companies as they kind of reviewed different strategic options and the like. On top of that, of course, we've seen changes in valuation expectations. And so, what we've seen previously is that maybe, you know, in the height of '21, there -- in our opinion, unrealistic expectations with respect to valuations. And so, those valuations have all come down, particularly in line with private and public capital markets.\n\nWe, of course, you know, in the grand scheme of things, are really trying to pick through, you know, all these different companies that are in the market right now and trying to figure out which ones align with our operating strategy, which ones we can effectively kind of combine with our cross-sell and upsell strategies, and which ones will kind of accretively add toward our P&L. So, that is something that we continue to do every single day. We are in market right now with several companies that we are pursuing on a pretty aggressive basis. And, hopefully, we'll be able to kind of provide some incremental news for everybody in the short term here.\n\nMike Latimore -- Northland Securities -- Analyst\n\nOK. Great. And then, I guess just last, any use cases that you see sort of where demand is intensifying or slowing early?\n\nJosh Resnick -- President and Chief Operating Officer\n\nHey. So, this is Josh. I can address that. Generally speaking, Tim touched upon in his remarks, we're actually seeing a significant need around companies who need to track regulation globally, so as they face, you know, issues that are existential for their business.\n\nAnd then, beyond that, around identifying and assessing needs related to changes in their business, whether it's seeking out incremental revenue opportunities that might be associated with government contracting opportunities, you know, as they're looking for every new opportunity in this environment, or even as they're looking to dial back operations in certain areas and wanting to understand the potential regulatory risks that they might have associated with that, or even understanding some of the economic forecasting associated with that. So, the use cases, one of -- in the private -- sorry, the use cases in the private sector tend to be pretty broad. And then, as Tim touched upon earlier, on the public sector side, it tends to be fairly steady around needs that are kind of generally consistent across the board in government.\n\nTim Hwang -- Founder and Chief Executive Officer\n\nOne of the things I mentioned in my remarks, of course, is that we effectively are thinking a lot about these \"trigger events.\" These trigger events are effectively areas where there's some political action that happens, and then there's an onslaught of, you know, demand or requirements by customers. And so, you can probably imagine a number of these trigger events being, you know, things like new proposed legislation in Congress, or a monumental Supreme Court opinion that changes regulatory environments, new trade, you know, kind of, you know, agreements, or whatever the case may be. And so, these trigger events are something that we watch out for quite aggressively. And I think we've talked about this in our last earnings call that, you know, the teams internally are very, very attuned to try to identify what those trigger events might be and effectively going after them, you know, using marketing campaigns or sales collaterals to try and really solve those problems for our customers on a day-to-day basis.\n\nMike Latimore -- Northland Securities -- Analyst\n\nOK. Great. Yeah. Thank you.\n\nOperator\n\nYour next question comes from the line of Rudy Kessinger from D.A. Davidson. Your line is open.\n\nRudy Kessinger -- D.A. Davidson -- Analyst\n\nHey, guys. Thanks for taking my questions. As I look at the revenue guidance, I mean, I know you hadn't previously given a GAAP revenue guide. But based on the non-GAAP revenue projection of 127 million and the run-rate and the deferred revenue adjustment, I mean, it seems like the prior guide is probably sitting around 123 or 124.\n\nThat's where the Street was sitting. So, you're taking it down by, you know, 11 million with just a quarter to go. And you guys reported pretty late on August 15th. And so, what changed in the macro? And how quickly did it change? And in hindsight, did you underestimate the macro impact at that point in time when you reported Q2 and gave the guide? And secondly, just with the magnitude as we take down the revenue guidance, where were your Q3 bookings relative to plan?\n\nTim Hwang -- Founder and Chief Executive Officer\n\nWell, so, I think I mentioned this, you know, in a portion of my remarks here that, you know, a lot of what we were looking at was, in 2022, the uncertainty that really popped up in September of this year or the like. And so, as we were looking at, you know, going into 2022, we were fairly confident that we were going to kind of hit the run-rate revenue guidance. We took that to account when we were providing those estimates. It really wasn't until September that we began to see these impacts from a new logo sales perspective.\n\nSo, you know, I think I mentioned this before, but these decision-makers are effectively starting to adjust their budgets on a pretty aggressive basis. And these sales cycles we saw were effectively elongating pretty dramatically and, you know, effectively something that we just had not anticipated. So, I do want to reiterate again, though, that, you know, in many of our kind of segments, particularly in the ones we just announced this morning, we do see continued ARR growth. We do continue to see our net retention continue to stay fairly steady.\n\nAnd so, it wasn't like there was any major change in the demand for our products or the need for our products. It was just when you're looking at the new bookings of our customer base, those sales cycles are effectively elongating. And so, it's hard to predict in that type of environment, you know, whether our sales -- the sales cycle will be four months or six months or nine months. I mean, that's why we're being a little bit more conservative when it comes to taking the December 31st point in time and what we expect our run-rate revenue to be at that point.\n\nJon Slabaugh -- Chief Financial Officer\n\nAnd, Rudy, to the second part of your question with regards to the GAAP versus where we expect it to be, we are, at the end of the third quarter, between $7 million and $8 million behind our original projections on run-rate revenue. And we were also kind of seeing -- taking adjustment against Q4 just to be conservative going forward. But we are seeing momentum now rebuilding the sales pipeline as well. But that's why we took the run-rate revenue estimate down.\n\nAnd as a result, as you can imagine, the flow through the GAAP revenue corresponds.\n\nRudy Kessinger -- D.A. Davidson -- Analyst\n\nYeah. OK. I guess -- and again, there's several different ways you could look at it. I guess one way, you know, the consensus -- and again, kind of your prior projections, we're looking for GAAP revenue go from about 27 million in Q2 to 38 million in Q4.\n\nSo, about 11 million growth. And now, you're effectively targeting, you know, just 3.5-ish million growth at the midpoint of the guide. So, again, that's substantial of a takedown of the guide. To what extent -- you know, if you look at it between the macro and just sales execution, irrespective of the macro, to what extent maybe poor sales execution outside of the macro impact results in the quarter in the updated guidance?\n\nJon Slabaugh -- Chief Financial Officer\n\nFirst of all, just to clarify one thing, this is the first time we initiated through GAAP revenue guidance. There is GAAP revenue that was kind of built on consensus as a result of looking at our run-rate revenue. I don't think that there's sales execution issue to really speak to. I think that -- and, Josh, you can weigh in, but the new logo acquisition is really the source of the shortfall.\n\nIs there anything you want to add there?\n\nJosh Resnick -- President and Chief Operating Officer\n\nNo, that's right, Jon. I mean, what we've seen has been exactly what we said, where it's a macro issue that is not specific to any particular individual or team. We have -- and as Jon was just saying a few minutes ago, we're actually seeing some of that thaw in the pipeline now. And so, while we're being conservative in the forecast, we do feel like we're seeing some promising trends.\n\nOperator\n\nAnd your next question comes from the line of Ben Piggott from EF Hutton. Your line is open.\n\nBen Piggott -- EF Hutton -- Analyst\n\nHey, guys. Appreciate you taking the question. Just on the concept of sales cycles elongating a little bit, any thoughts on using price as a tool to close as you go to year-end? Or do you really kind of holding the line on the line pricing dynamics of the product?\n\nJosh Resnick -- President and Chief Operating Officer\n\nSure. I can address that. I mean, you know, we're obviously thinking about all the opportunities we have in front of us in the ways that we can promote our products. You know, as Tim said, the way we think about even events on the political landscape that might trigger buying opportunities for our clients.\n\nSo, we're really looking at all the opportunities we have in front of us to maximize revenue in the fourth quarter and beyond. We actually think that, you know, our products are of substantial value to our clients. And we've actually seen actually some overall success in regards to our contract values and our pricing. And so, we haven't felt the need to discount -- don't want to, you know, of course, discount the value with them as well.\n\nBut we are thinking expansively about what we need to do in order to drive revenue, both in the near term and long term.\n\nBen Piggott -- EF Hutton -- Analyst\n\nGreat. Thank you.\n\nTim Hwang -- Founder and Chief Executive Officer\n\nI also want to mention that our entire growth strategy, you know, is really predicated on this ability to drive those cross-sells and upsells. And there is a fairly strong correlation between the level of commitment that our customer is going to give to our products and the ability for them to kind of continue to stay with us in the long term. And so, you know, as we think about, you know, bolt-on M&A strategies, new product innovations, and new growth, you know, we have seen, you know, continued increases in our average contract price Josh mentioned. And that's, of course, you know, bundled with our increasing or stable net retention rates.\n\nYou know, we are -- we just want to really drive the value of our products even on this macro environment. So, it is a lever, but it's not one that we're using right now.\n\nBen Piggott -- EF Hutton -- Analyst\n\nGreat. Thanks, guys.\n\nOperator\n\nAnd there are no further questions at this time. Mr. Tim Hwang, I'll turn the call back over to you for some final closing comments.\n\nTim Hwang -- Founder and Chief Executive Officer\n\nAll right. Well, appreciate everybody jumping on the call here. As you mentioned, we are very committed to building a long-term growth compounding business. It's something that we're very excited about and will continue to do in the future.\n\nSo, appreciate everybody jumping on the call. And if you have any further questions, feel free to reach out to Sara Buda or Jon Slabaugh on our team. Thank you.\n\nOperator\n\n[Operator signoff]\n\nDuration: 0 minutes\n\nSara Buda -- Vice President, Investor Relations\n\nTim Hwang -- Founder and Chief Executive Officer\n\nJon Slabaugh -- Chief Financial Officer\n\nMatt VanVliet -- BTIG -- Analyst\n\nJosh Resnick -- President and Chief Operating Officer\n\nMike Latimore -- Northland Securities -- Analyst\n\nRudy Kessinger -- D.A. Davidson -- Analyst\n\nBen Piggott -- EF Hutton -- Analyst\n\nMore NOTE analysis\n\nAll earnings call transcripts"}
{"id": "00ede428-28fd-4c11-9c5c-6c22000a730e", "companyName": "Seer, Inc.", "companyTicker": "SEER", "quarter": 4, "fiscalYear": 2021, "sourceUrl": "https://www.fool.com/earnings/call-transcripts/2022/03/01/seer-inc-seer-q4-2021-earnings-call-transcript/", "content": "Seer, Inc.\u00a0(SEER -6.91%)\nQ4\u00a02021 Earnings Call\nFeb 28, 2022, 4:30 p.m. ET\n\nOperator\n\nGood day, and thank you for standing by. Welcome to the Seer fourth quarter and full year 2021 earnings conference call. [Operator instructions] Please be advised that today's conference may be recorded. [Operator instructions] I would now like to hand the conference over to your host today, Carrie Mendivil, investor relations.\n\nPlease go ahead.\u00a0\n\nCarrie Mendivil -- Investor Relations\n\nThank you. Earlier today, Seer released financial results for the quarter and year ending December 31, 2021. If you have not received this news release or if you'd like to be added to the company's distribution list, please send an email to investors@seer.bio. Joining me today from Seer is Omid Farokhzad, chairman, chief executive officer, and founder; and David Horn, chief financial officer.\n\nBefore we begin, I'd like to remind you that management will make statements during this call that are forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated. Additional information regarding these risks and uncertainties appears in the section entitled Forward-looking Statements in the press release Seer issued today. For a more complete list and description, please see the Risk Factors section of the company's yearly report on Form 10-K for the year ending December 31, 2021, and in its other filings with the Securities and Exchange Commission.\n\nExcept as required by law, Seer disclaims any intention or obligation to update or revise any financial projections or forward-looking statements, whether because of new information, future events, or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast, February 28, 2022. With that, I'd like to turn the call over to Omid.\u00a0\n\nOmid Farokhzad -- Chairman, Chief Executive Officer, and Founder\n\nThanks, Carrie, and thanks, everyone, for joining us this afternoon. 2021 was a momentous year for Seer. We had a strong first year as a publicly traded company with the commercial launch of our product and tangible progress across all areas of our strategic plan. These significant efforts resulted in $6.6 million in revenue for the year and laid the foundation for broad release of the Proteograph Product Suite.\n\nWe shipped 17 instruments to our collaborators and customers by the end of 2021. We completed the first two phases of our commercialization strategy and onboarded lighthouse customers across multiple market segments, which paves the way for future market adoption and exemplification of the unique capabilities of our technologies. We demonstrated the power of this technology together with our customers with more than 25 abstracts across a number of scientific conferences. We established partnerships with industry-leading mass spec providers, Thermo Fisher, Bruker, and SCIEX and presented results on our joint workflows.\n\nWe made great strides in strengthening teams across the organizations, including commercial, operations, quality, data science, and R&D. We made significant progress building our operation infrastructure, including systems and lab space, and executed contracts with key suppliers and partners to support our growing customer base globally, all while minimizing disruption to the business during the COVID pandemic. We also continued to build our board of directors, adding strong operating leaders representing a cross-section of industries, company sizes, and market segments. I couldn't be more pleased with the progress we made in 2021 and are more confident than ever as we're squarely focused on the customer experience and the broad release of the Proteograph Product Suite.\n\nI had previously shared at the J.P. Morgan healthcare conference in early January that we officially entered into broad release and have built a strong pipeline of demand for the Proteograph Product Suite. I'm encouraged by the depth and breadth of discussions we're having with potential customers. We believe we are well-positioned to become the definitive tools leader in proteomics.\n\nWe envision a future in which entire ecosystem that end markets will be created or expanded with customers using the Proteograph Product Suite to access unbiased, deep, rapid, and scalable proteomics across a myriad of applications. Heading into 2022, we are continuing to ramp our commercial efforts to meet this expected demand. Over the course of the year, we will be focused on five key objectives: First, growing our installed base of instruments. Second, expanding our partnership efforts to continue to extend our global reach, making it easy to access our technology and allow us to serve a diverse customer base.\n\nThird, supporting customers with an industry-leading onboarding and user experience so they can get up and running quickly. Fourth, continuing to build out our commercial capabilities, geographic footprint, and team. And fifth, driving the product road map and exploring more applications for proprietary engineered nanoparticles in 2022 and beyond. We have a strong pipeline of prospective customers with a roughly equal mix of academic and commercial entities.\n\nWe're seeing interest across a broad range of applications, including biomarker discovery and target identification for drug development. For diseases such as neurodegenerative diseases, oncology, cardiovascular, and other complex diseases. And for market areas, such as reproductive health, aging, veterinary direct-to-consumer and population-scale initiatives. The Proteograph Product Suite is performing exceptionally well in customers' hands.\n\nWe routinely receive positive feedback about the product usage, installation, and support experience. And this, I'm very proud of. We have built the foundation for customers to log in and self-serve online and we're launching a customer portal to enable this capability in the first quarter. The ease of onboarding and the power of our technology to deliver insight is demonstrated by how quickly limited release customers are presenting their data.\n\nEven small proof of principle studies using the Proteograph Product Suite have generated exciting results and presentations at conferences. Larger studies are beginning in aging, cancer, and complex diseases. Oregon Health & Science University, one of our collaboration sites, is running their study of approximately 1,000 samples in the first quarter, and they're currently about halfway through processing their samples. We expect they will submit abstracts later this year.\n\nDuring this week's U.S. HUPO conference in New Orleans, we're presenting seven posters, some in collaboration with our customers, demonstrating the power of unbiased proteomics at scale. In addition, there is an eighth poster that will be presented by PrognomIQ, sharing the analysis of enlinked glycans in cancer patients using the Proteograph Product Suite. Their study of 212 subjects inclusive of 96 healthy controls yielded hundreds of glycopeptide.\n\nImportantly, this demonstrates the Proteograph Product Suite's ability to detect glycosylated proteins. Glycosylation is a common post-transitional modification and is involved in the normal functioning of the cell and in the development of diseases such as cancer. Previously, these glycoproteins could only be robustly identified utilizing specific enrichment strategies. In one of our own posters being presented at the U.S.\n\nHUPO, we're demonstrating our new software package, the Proteograph Analysis Suite, which leverages our scalable, cloud-based software for large-scale proteogenomic data alliances and visualization. Another poster being presented demonstrates the high proteom depth, ability to identify new protein variants, and the reproducibility of our technology in customers' hands with a 1% false discovery rate for protein identification. This was shown in the study with a cohort of 200 individuals, including Alzheimer's disease patients and healthy controls. Across this cohort, we identified at least 5,500 protein variants, inclusive of 4,700 unique protein groups at 1% false discovery rate.\n\nLooking at this data at peptide level resolution, we identified over 63,000 peptides, inclusive of more than 1,350 unique peptide allele variants. Importantly, more than 500 of these peptide variants have not been previously reported in the major public peptide repositories or in the ClinVar genomic variant database. This is a key benefit of our technology. Our solution is the only available at scale technology to deliver peptide and amino acid level resolution, which is needed to match with nucleotide level genomic information in order to broadly enable proteogenomics.\n\nAs studies scale to larger cohorts, we expect to find increasing catalogs of protein variants, including alleles, splice forms, and post-transitional modification to enable increasingly more powerful proteogenomic analysis. At scale, we believe this kind of novel biological insight will be key to unlocking the proteome and likely lead to applications and therapeutics not otherwise possible. Geographically, we're seeing a growing interest across North America, Europe, and Asia and as a result of our expanding commercial footprint. In addition to our ongoing efforts in North America and Europe, we're diligently working through COVID constraints to establish our presence in China with installation and training occurring this month at our distributor Enlight Medical.\n\nWe're in an excellent position to expand our installed base in 2022 and are eager to continue to get the Proteograph Product Suite into customers' hands and see the biological insight grow. Earlier this year at the J.P. Morgan healthcare conference, we announced the launch of our Center of Excellence program, a program that partners Seer with select premier multiomic service providers to offer unbiased deep proteomic services to customers around the world. We have strategically selected each COE based on geography and expertise.\n\nIn North America, we have Biodesix, Discovery Life Sciences, and Sanford Burnham Prebys Medical Discovery Institute, with services and expertise targeted at pharma, genomics, and academic customers group, respectively. Outside of the U.S., we have partnered with Evotec in Europe and Soulbrain in South Korea. These partners are at varying stages of commercializing their services using the Proteograph Product Suite and the majority of them are ready to go and have already received inquiries since our announcement at J.P. Morgan.\n\nWe also announced a key collaboration to expand access of deep unbiased proteomics for genomics customer to enable proteogenomics and multiomic studies at previously unimaginable scale. Together with Discovery Life Sciences, a leaning genomic service provider and one of our COEs; and SCIEX, one of our current commercial partners and a leading provider of mass spec platforms, we have created a first-of-its-kind proteogenomic consortium. This is a multiyear collaboration that incorporates a three-phase expansion where Discovery will set up, expand and offer deep, unbiased proteomic capabilities to their existing genomic customers, ramping toward an annual capacity of over 100,000 samples per year. This is, of course, done using the Proteograph Product Suite and the SCIEX ZenoTOF 7600 platform.\n\nWe expect the consortium to become operational in the second half of 2022 and look forward to updating you on this progress. I'm extremely pleased with the execution of our commercial strategy over the past year. None of this would have been possible without the critical talent to drive progress across these important fronts and we have more than doubled our organization in 2021. We have also continued to build a diverse and experienced board with new members, including Meeta Gulyani, a seasoned life science and pharma leader with global experience across markets, including Asia; and Rachel Haurwitz, a highly accomplished and distinguished scientist and CEO in a high-growth emerging area of gene editing.\n\nWe're very proud of our progress in attracting top-performing, passionate people to Seer team and we believe this is the fuel to drive our business as we head into 2022. We are engaged with top institutions and scientists across the world to enable unbiased deep proteomics at scale. We're seeing first-of-their-kind, unbiased large-scale projects being planned and funded. We're seeing robust performance on the product in customers' hands with compelling data being presented just months after gaining access to the technology.\n\nAnd we're building a strong pipeline across markets and customer groups as we continue to scale our commercial organization to open up a new gateway to the proteome and unlock this exciting opportunity ahead. And with that, I will now turn the call over to David.\n\nDavid Horn -- Chief Financial Officer\n\nThanks, Omid. Total revenue for the fourth quarter of 2021 was $3.1 million, compared to $336,000 in the fourth quarter of 2020. This brought total revenue for the full year 2021 to $6.6 million, compared to $656,000 in 2020. The increase in fourth quarter revenue was primarily due to sales of products related to the Proteograph Product Suite.\n\nProduct-related revenue for the fourth quarter of 2021 was $3 million, including related party revenue of $1.2 million, and consisted of sales of SP100 instruments, consumable kits, and platform evaluations. Related party revenue of $1.2 million represents product sales to PrognomIQ. Grant and other revenue from our SBIR grant from the NIH and research-related collaborations was $34,000 in the fourth quarter of 2021, representing a decrease in these activities from the fourth quarter of 2020. Total gross profit, inclusive of grant and other revenue, was $1.4 million for the fourth quarter of 2021, representing a gross margin of 47%.\n\nTotal gross profit for the year was $3.4 million, representing a gross margin of 52%. Full year gross margins benefited from strong consumable kit sales, platform evaluations, service projects, and grant revenue. In 2022, we expect gross margins will be dampened due to an anticipated larger percentage of instrument sales, a significant reduction in service and grant revenue, and our continued investment in and scaling of our operations. As we have discussed previously, we continue to target long-term gross margins between 70% and 75%.\n\nTotal operating expenses for the fourth quarter of 2021 were $21.3 million, compared to $13.4 million in the fourth quarter of 2020. Total operating expenses for 2021 were $74.9 million, inclusive of $25.9 million in stock-based compensation compared to $34.3 million, inclusive of $7.3 million in stock-based compensation in 2020. Research and development expenses for the fourth quarter of 2021 were $8.2 million, compared to $5.4 million in the fourth quarter of 2020. Research and development expenses for 2021 were $29.1 million, compared to $18.9 million in 2020.\n\nThe increase in R&D expenses was primarily driven by an increase in product development efforts related to the Proteograph Product Suite, including increased headcount and other expenses related to employee compensation, including stock-based compensation. Selling, general and administrative expenses for the fourth quarter of 2021 were $13.1 million, compared to $8 million in the fourth quarter of 2020. SG&A expenses for 2021 were $45.8 million, compared to $15.4 million in 2020. The increase in SG&A expenses was primarily driven by increased headcount and other expenses related to employee compensation, including stock-based compensation.\n\nIn addition, we incurred increased marketing costs related to our commercialization efforts as, well as increased costs, related to being a publicly traded company. Net loss for the fourth quarter was $19.7 million, compared to $12.9 million in the fourth quarter of 2020. Net loss for 2021 was $71.2 million, compared to $32.8 million in 2020. We ended the year with approximately $493 million in cash, cash equivalents, and investments.\n\nTurning to our outlook for 2022. We expect revenue to be in the range of $14 million to $16 million. We expect revenue to consist primarily of sales of the Proteograph Product Suite, which includes SP100 instruments, consumable kits, and software. At this time, we do not expect significant revenue from service-oriented projects or grant revenue.\n\nIn 2022, we also expect to continue to increase our investments across commercial, operations, and R&D activities in order to scale our business and drive long-term revenue growth. We believe we are adequately capitalized to execute on our strategic plan and remain thoughtful and prudent with our deployment of capital in order to drive long-term value creation. At this point, I would like to turn the call back to Omid for closing comments.\u00a0\n\nOmid Farokhzad -- Chairman, Chief Executive Officer, and Founder\n\nThanks, David. As we move forward in pursuit of our vision this year, we will continue to drive execution against our core strategies. I'm excited and humbled to lead such an amazing team I'm inspired by the passion, the hard work, and the dedication that has allowed us to commercialize such a transformative product. I believe we have a technology, the team, and the strategy to bring the next phase in omics to labs around the globe.\n\nWe're paving the way for a portfolio of products that will open a new gateway to the proteome. We look forward to sharing updates on our progress over the course of the year. And with that, we'll now open it up for questions.\u00a0\n\nOperator\n\nThank you. [Operator instructions] Our first question comes from the line of Tycho Peterson with J.P. Morgan. Your line is open.\n\nPlease go ahead.\n\nTycho Peterson -- J.P. Morgan -- Analyst\n\nHey, thanks. I'd like to start with the guide. Wondering if you could just give us any more color in terms of how you're thinking about instruments versus consumables. And then you did call out a step-up on opex.\n\nCurious if you could just help us frame the magnitude of how you think about that step-up and anything you could point to in terms of where the dollars are going? How much is going to the commercial channel versus R&D?\u00a0\n\nDavid Horn -- Chief Financial Officer\n\nSure. Tycho, it's David. Thanks for the question. In terms of instrument versus consumable, we do feel like it's going to, again, be majority instrument relative to consumable.\n\nWe're not going to give you exact percent. But again, I think it would be something we still see good consumable pull-through in revenue. But again, we think it's going to tip the balance toward instruments next year. And then in terms of opex, we -- again, we're not going to give you a specific guidance on that.\n\nBut again, I think we are going to continue to see good investment across the organization, both in terms of operations and commercial. I think that's probably going to be the key investment area. And then product development, we're continuing to invest in our product pipeline. And then obviously, R&D to kind of continue to seed the efforts and investments for long-term growth.\n\nBut again, we do see opex increasing. Obviously, headcount increased. And we will, again, be prudent with those investments. We feel like we're very well capitalized today to execute on the plan.\u00a0\n\nTycho Peterson -- J.P. Morgan -- Analyst\n\nAnd then a follow-up on just the road map. You're currently doing around 2,000 plex. Some of your competitors have higher plex. I'm just curious if you could talk about plans to increase multiplexing over time.\n\nIs there a road map you can kind of point to in terms of where you might go from a multiplexing perspective?\n\nOmid Farokhzad -- Chairman, Chief Executive Officer, and Founder\n\nTycho, thank you. So from a product road map perspective, Tycho, we're focused really on kind of three areas in the near term and then some additional areas a bit further out. In the near term, as we put the product in the customers' hands, the feedback that we received, which by the way, obviously mirrors the programs that we have internally, were that customers were looking for increased throughput. And the Proteograph really significantly adds the ability to do larger and larger studies, but you still have some limitation at the mass spec level.\n\nSo they wanted to increase throughput even at the mass spec level. So that was one. Second area was reduction in sample volume so that if you have a precious sample, especially a biobank sample, you can start off with a lower amount. And then third was increased content.\n\nAnd by that, I mean a larger number of protein IDs on a per-sample basis. Remember, when we talk about -- in Seer, when we talk about protein IDs, we're talking about the protein that are identified in a given sample at a 1% false discovery rate. This is an important point. So for example, the five nanoparticle panel that we have, if you look at it across the various different studies, they can identify -- I mean, to date, we have identified and we've actually discussed that, Tycho, at your own conference just a couple of months ago, north of 12,000 proteins.\n\nAnd that number, by the way, is increasing. So for example, if you just look at the Alzheimer's study that I alluded to in my prepared remarks, in that study, we're now north of 5,500 proteins, inclusive of some protein variants. So I think from a content perspective, Tyc