Q4 2022 Live Oak Bancshares Inc Earnings Call
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Good day, and thank you for standing by and welcome to the Q4 2022 Live Oak Bancshares, Inc. Earnings Conference call. At this time, all participants are in a listen only mode.
Speakers presentation there'll be a question and answer session to ask a question during that session you'll need to press star one on your phone you will then hear an automated message advising that your hand is raised to withdraw your question. Please press star one again.
Today's conference is being recorded and I would now like to handle conference over to your speaker today, Mr. Greg Seward, Chief risk Officer, and General Counsel.
Sir Please go ahead.
Thank you and good morning, everyone. Welcome to live Oak's fourth quarter 2022 earnings Conference call. We are webcasting live over the Internet and this call is being recorded to access the call over the Internet and review the presentation materials that we referenced on the call. Please visit our website at Investor RBI Live Oak Bank Dot com.
Today's call on our event calendar for supporting materials.
Our fourth quarter earnings release is also available on our website.
Before we get started.
We may make forward looking statements during today's call that are subject to risks and uncertainties.
Or is that may cause actual results to differ materially from our expectations are detailed in the materials accompanying this call and in our efficacy fibers.
Undertake to update the forward looking statements to reflect the impact of circumstances or events that may arise. After the date of today's call.
Information about any non-GAAP financial measures referenced including reconciliation of those measures to GAAP measures can also be found in our SEC filings and in the presentation materials I will now turn the call over to chip Mahan, our chairman and Chief Executive Officer.
Thanks, Reg and good morning to those dialing in today.
If I had your job bank analyst extraordinary.
My first question would be tell me about your loan loss provision.
Moving to the next slide Micah.
Before we unpack the provision in our last quarterly call, we talked about some very famous photos predicting a recession.
So are the last two substantial increases in the provision a proxy for the future.
Let's drill down.
Slide.
Let's go way back to pre seasonal to provision in 2018, and 19 was between zero and $7 million.
Mainly in the $2 million to $5 million range. Then in Q1 of 2020, we implemented Cecil at the beginning of the pandemic.
We were predictably conservative providing $10 million per quarter during the <unk>.
Covid peak.
We were equally predictable is the government provided PPP funding and our provision came down in 2021 as you can see from this slide.
The title of this slide is regression to the norm.
We're about back to where we were three years ago as our allowance for credit losses, or two 2% up on guaranteed loans compared to two 4% in 2019.
We do not see the Q4 provision as a proxy for the future at this point in time.
Moving to slide six.
In the old days of running banks, we typically added to our loan loss reserve that which we charged off that quarter not anymore. As you can see our addition to the reserve has far exceeded actual net charge offs BJ will be walking you through some calculations on how growth in the loan portfolio has a great deal to do with these different.
Yes.
Let's move to slide seven market.
There's always back to credit quality and the underpinning of a building of a healthy allowance for loan losses, once again soundness profitability and growth in that order.
So here are the facts watch list is down year over year past dues are flat non accruals are down 10 bps.
As we discussed last quarter surprisingly of the total non accruals at year end, a $26 million over half or $15 million or paying as agreed.
Charge offs in 'twenty, one were $9 million and a $10 7 million in 2022.
De Minimis on our loan book of $4 1 billion above guaranteed paper.
Slide eight.
Now that we have examined the past and reconciled the history of our loan loss reserve and our current credit quality ratios what does the future look like.
What better place to turn that our customers.
I have known John Barlow for a long time, John started his data driven consultancy 43 years ago.
He asked John and his team to ask our customers a number of questions about the future of their businesses.
After a thorough review enlist cleaning 4600 loan relationship customers.
To participate in an online survey between late September and early November .
768 customers or 17% of the total responded.
As you can see from this slide most were upbeat and over 60% thought they could grow their revenues in 2023, nearly 25% of our customers plan to borrow money to finance that growth over the next 12 months.
Relative to customer challenges difficulty in hiring and increased material and supply costs topped the list.
Half of our customers believe they are under staff over the past 12 months most customers have increased their prices over 10%.
Over the next five years, 25% of our customers believe they could sell their business.
This doesn't feel like a recession does it.
Over to you Vijay.
Thanks Chip.
Good morning, everybody. Thanks, again for joining us, let's let's start on some full year 2022 highlights on slide 10 earnings per share were $3 92.
From a core earnings results perspective, they were driven by healthy production growth $4 billion of production in the year, leading to strong loan growth. This combined with net interest margin resiliency led to excellent net interest income growth.
And then of course, we had significant gains for a successful exit for two ventures investments, which gave us the flexibility to moderate our guaranteed sales activity due to market dislocation and continue investing in our people and technology.
While adding meaningful organic capital.
Put some numbers behind that highlights the full year 2022, net interest margin of 387 held up incredibly well ahead of expectations. This is a testament to the excellent discipline, our lenders demonstrated to balance production and profitability along with the great work by our deposits team to manage the <unk>.
Positive pricing in a very highly competitive rapidly rising rate environment.
Our adjusted net interest income growth was up 31% year over year on that $4 billion of loan production and 24% loan growth ex PPP, along with 25% deposit growth.
This balance sheet growth was made even stronger by the guaranteed loans, we did not sell while gain on sale income was down meaningfully from last year due to the secondary market dynamics that income was not last forever.
Loans that we kept will be a strong tailwind to our balance sheet and growth in 2023.
Chip said credit quality remains quite strong despite the uncertainty of the economic outlook and of course, our history of successful incubation and investment in Fintech ventures, again served us well generating significant gains inorganic capital for future growth.
All of this led to significant tangible book value per share growth as well, 12% year over year.
As we look at slide 11.
We also note that our 2022 results had a lot of moving parts that didn't make it easy for investors a few comments on these as we head into 2023.
Five quick points.
Number one PPP loans and associated impacts are immaterial at this point and won't be a factor going forward.
Number two while we will continue to mark our servicing asset each quarter as required we are working on ways to better forecast and minimize its impact on our quarterly results.
Number three while we will continue to make tax credit investments when attractive we are modifying our strategy to lessen the earnings volatility associated with those investments.
Number four we plan to keep gain on sale income as a percentage of total revenues more than current ranges, which will afford us additional flexibility and stronger recurring spread income growth.
And number five while we continue to find our existing live oak and canopy ventures' investments attractive and we will continue to make further investments. We are not currently anticipating any exits in the near term.
Turning to slide 13, let's take a quick look at Q4 'twenty two performance, where you see our adjusted results and the notable items that make up those adjustments.
Adjusted <unk> was down 12% quarter to quarter as continued strong net interest income growth of 4% linked quarter was offset by lower gain on sale income and continued investment in people and technology.
Chip discussed earlier, our credit remains quite healthy we did build our provision proactively in anticipation of a potential recession in 'twenty three I'll get into credit trends, a little bit more fully in a few minutes.
Turning to slide 14, we generated almost $1 2 billion of loan production in the quarter and 4 billion for the year you see our loan originations remained quite diverse across our multiple areas with particular strength in numerous small business verticals.
And our middle market sponsor finance vertical and energy and infrastructure solar remains quite strong while bioenergy lending was down from last year, both of those verticals should benefit from the clean energy incentives in the recently passed inflation reduction Act.
Breaking down the components of revenue on slide 15.
We see very strong and encouraging revenue trends, particularly in net interest income while linked quarter revenue was down modestly as continued NII growth was upset by lower gain on sale income total revenue growth was up 16% year over year, even with significantly lower gain on.
Sale income, thanks to 31% year over year growth in net interest income.
Given the fact, we held more loans on the balance sheet and expect to continued healthy NIM. We are optimistic about continued strong NII growth in 2023.
Secondary market for SBA, and USDA fixed rate sales remain unattractive and pricing for variable rate SBA is recovering, but still not quite at normalized levels. So we expect to continue to hold more assets on the balance sheet.
Again, it's important to understand that lower gain on sale income is not income that is permanently lost we simply earn it over time in the form of spread income and because of the flexibility we have with strong capital and liquidity levels. We are more than happy to hold these high quality assets.
We remain patient with secondary market sales until further further normalization.
Digging deeper into net interest margin trends on slide 16 margin again held strong in Q4 at $3 76 and for the full year at $3 87 versus last year's 386, while we still expect some downward pressure as deposit competition shows no signs.
Of easing we continue to be very encouraged by the resiliency of our margin due to the excellent work by our lenders and adjusting loan pricing commensurate with market funding costs.
Turning to expenses on slide 17.
We have been incredibly pleased with the quality of talent that has joined <unk> and our various groups across the company. We have now largely work through our hiring bubble to right size, our lender support to accommodate the significant step up in <unk>.
Production and balance sheet growth over the past two years and in addition, as we have discussed we accelerated our technology hiring in 2022, thanks to the things that gain that is now largely complete so going forward, while we will continue to be opportunistic on hiring particularly for revenue.
Producers, we expect to see our expense growth.
Both moderate considerably into 2023 and significantly improve our operating leverage and PPR growth going forward.
A few more points on credit trends on slide 18, as chip discussed earlier credit metrics remained quite strong we continue to actively monitor the existing portfolio and do not currently see any glaring weak spots net charge offs and non accruals remained quite low 30 day past dues remained low as well in fact.
<unk> the Q4 dollar amount of $19 million you see in the upper right is down to only about $3 million as of yesterday, yes.
Yet we grew the provision well in excess of the $1 4 million of net charge offs, we experienced in Q4.
And as you can see in the upper left 40% of that provision was due to strong balance sheet growth to me. That's that's good provision.
55% of the growth with continued proactively and building appropriate reserves for a less certain outlook and regressing to the norm.
With what we see combined with a conservative outlook. We currently feel very well positioned with our current reserve coverage levels.
Slide 19 shows the advantages that the LIBOR business model.
Having 42% of your total loan portfolio of government guaranteed a stronger net interest margin and most and reserves over twice the industry average is quite unique and comforting.
Add to that our overall capital strength on slide 20, we believe we are.
Credibly well positioned to thrive in whatever environment lies ahead with that I'll turn it over to Huntley for a little more color on our outlook and areas of focus for 'twenty three huntley. Thanks P. J I'll try to wrap all this up on page 22.
Despite what was admittedly a noisy quarter and the continued sort of macro uncertainty as we head into 2023 with a lot of momentum from from day, one of live oak, you've heard chip articulate our priorities as a company safety and soundness profitability and growth in that order and we remain committed to that our balance sheet as BJ went through it.
Really well positioned with ample capital significant loan loss reserves and the flexibility that we required to support our growth our loan portfolio remains healthy and we're committed to staying close to our existing small business borrowers and were optimistic as they navigate a slower growth economy.
That said, we still see tremendous opportunity to continue to lend prudently, especially if history repeats itself and lenders pulled back from small businesses and choppy times.
In 2022, we demonstrated our ability to maintain our net interest margin. Despite the rapidly rising rate environment and that coupled with continued loan growth should position us for significant net interest income growth as BJ mentioned, we've been spending a lot of time focusing on how to reduce the volatility in our earnings to make your jobs as investors easier to see our core fundamentals.
And expect to demonstrate that in 2023 as well.
On the expense side, our team is firmly in place as we start the year and our head count growth will dramatically slow versus the last couple of years, our lending franchise is stronger than ever our technology team is fully built out with a clear roadmap and we are seeing tangible efficiency gains in both our technology investments and our operational improvements all of that should allow our revenue.
Growth has significantly outpaced our expense growth and result in strong <unk> growth throughout the year.
On the technology front, you'll see continued improvements in our origination and servicing platforms designed to speed up our lending process and improve our customer experience.
We also see our embedded banking developer portal that will drive customer acquisition and deeper banking relationships through software providers that serve small businesses.
Wrap up with a topic that I'm sure you've all been waiting for an update on checking as you. All know we currently have a checking product and the lower end of the small business market with about 2000 accounts, but it doesn't have all the capabilities that we need to serve our core customers veterinarians the professional services firms and the rest of the small business America that require some version of entitlements.
And money movement.
In the next couple of weeks, we're going to onboard our first customer on our fully functional business checking account that is complete with treasury management capabilities and that will allow us to serve all of our existing small business clients and the broader small business market as well it's been a long wait for everyone, but we're excited to finally prove our ability to drive low cost deposit growth at live oak.
We remain laser focused on our mission to become America's small business Bank and we look forward to translating that into predictable earnings growth throughout 2023 with that let's turn it over to questions.
Thank you.
As a reminder to ask a question. Please press star one one on your phone and wait for your name to be announced to withdraw your question. Please press star one again.
Standby as we compile the Q&A roster.
Yes.
Our first question will come from Steven Alexopoulos of Jpmorgan. Your line is open.
Hey, good morning, everybody.
Hey, Steve.
I'd like to start so BJ you guided the NIM several quarters ago to $3 $53 75 in the fourth quarter Youre at $3 76. So I think one built showcases with that forecast what do you see as the range one year from now or 223.
Yes, I think.
I would probably still say the $3 50 or $3 75.
And hopefully again under promise and over deliver.
So as I talked about earlier feel really good about how quickly our lenders.
Adjusted loan pricing.
And and still put up record loan production as well so it's not like we sacrificed.
Quantity for profitability, so very pleased with that.
The deposit pricing was very.
Well managed by our team in the first half of 2022, and then it's significantly ramped up in the back half and shows no signs of slowing so I do expect in 2023, particularly in the first half of the year.
To see that.
<unk> pressure on the NIM as it relates to deposit pricing.
Because we won't see quite as much loan repricing.
That was helpful to us, but in the back half of the year.
Yes.
Continuing to build our margin as potentially the fed stops raising rates and rates in general are more stable. So still feel really good about the margin and and our ability.
<unk> to produce so happy with what we've seen so far.
P J.
<unk> does not cut rates the way the market thinks and they move up.
More hikes and then pauses do you still think NIM can hold in that range or is it really contingent on seeing rate cuts the back half.
No. It's a good good question.
We essentially are assuming what.
The market forward curve looks like so another two or three.
Fed moves of 25 basis points and then a cut either late late December 'twenty, three or early 2024. So.
Our margin assumptions for 'twenty, three really don't have any.
Rate cut that would have a meaningful impact.
Okay.
That's helpful and then to follow up on the comments around <unk>.
<unk> down the expense growth could you help us think about what's a reasonable range for 2023.
It's a good question, Steve look I think if you look back in 2021.
That's really in that sort of post pandemic or sort of capital flows in our lending volumes really stair stepped up and so we hired a bunch of lender lender support to keep up with that opportunity.
And then into 2022 it was really in the technology side, where we really invested heavily and we've talked about that as it relates to some of the gains that we had that allowed us to accelerate that both of those are really in place and so I think that if you thought about from a head.
<unk> perspective, we may still grow a little bit, but it'll be certainly less than 10%.
The board and Thats, assuming that our production still looks like it'll be at.
At or above where we came in last year with everything we see right now and that's obviously the driver the largest driver of our.
All of our expenses is on the people side.
So are you, saying high single digit is that about what you are implying.
If you look at if you look at 21% to 22 to take out kind of some of the noise or the one times that kind of thing we had about 25%.
Expense growth from 'twenty, one to 'twenty two.
I would see that more in the mid teens range this year as we.
As we put more of that investment in people and technology to work.
Yes, I think I think Steve the other way to think about it is we had a lot of growth throughout last year. So looking at Q4.
That sort of core expense number I think we will be in the high single digits or mid single digits of growth over that kind of call it less than 10% growth on that number but the bj's point that'll translate year over year higher just given the ramp up over the course of last year.
Steve I think the only thing that could upset that ray is back to your earlier point right.
If this is a true recession and if the credit guys end up running these banks and if there are opportunities to hire other lending officers, we will be we will be in that high.
But that is not predictable at this time.
Yes.
If I could squeeze in one last one just on credit.
Metairie around a small number of relationships.
You talked about impacting credit quality anything to read into there or any industry. One offs, just give a little bit of color there. Thanks.
Yes, Steve This is Steve Smits, Chief Credit Officer.
No systemic or anything to read into it.
I would say that's based on.
A handful of relationships that are going through some turmoil with their management teams.
Still paying as agreed however, we opted to reserve against those because we'll be potentially navigating some uncertain times and so I.
I don't suspect that there.
That is going to turn into losses, but it's kind of a conservative approach this reserve against that.
Because see if these management issues with our borrowers escalate, we will be prepared and ready for it. So it's kind of a conservative approach, but not anything systemic that jumps out these are.
Unrelated.
Issues.
Got it okay. Thanks for taking my questions.
Thanks, Steve.
Thank you.
One moment please for our next question.
Again, one moment our next question.
Yeah.
Our next question will come from Crispin Love a Piper Sandler Your line is open.
Thanks, and good morning, everyone. First one is on SBA gain on sale margins. So they were at 5% in the quarter well below recent quarters, but you did sell more SBA in the fourth quarter than you did in this area. So I'm just can you speak a little bit to your strategy, there and why you didn't balance sheet more loans in the fourth.
Similar to what you did in the second quarter and then just your expectations for selling versus holding on the balance sheet in early 2023.
Sure Kristen Hey, its BJ.
<unk>.
One thing that has been particularly.
Surprising and impressive about what our lenders have been able to accomplish is the beginning of the year.
30% to 35% of our production with variable rate.
So 60.
5% to 70% was fixed rate.
And that obviously was as we've talked about difficult to sell by the end of the year, we were over 50% variable rate in terms of the production that we were booking.
<unk> rate market was still relatively healthy.
Our gain on sale perspective, and so we had more capacity and more eligible loans for sale that were attractive to investors.
So as we looked at.
Where we would want to manage interest rate risk what kind of.
No.
Balance sheet, we wanted and what kind of gains that we thought we could take in the fourth quarter from <unk>.
<unk> sales we decided.
So a little bit more of the variable knowing that we had.
Quite a bit of it on the on the balance sheet already so that was part of.
The math there.
Okay. Thanks, PJ. That's helpful. And then do you have any early reads on the on the first quarter for margins have begun to firm a little bit or do you expect to have a little bit more of the same.
For near term trends.
Yes, so I'd say that.
The variable rate.
Market continues to heal its probably still.
A couple of hundred basis points from quote normal levels, but there is there is healthy activity and there is buying.
If we choose to to be in the market and sell USDA and SBA fixed rate product is still a virtually nonexistent from a buying perspective. So we.
We will be holding those.
So like I said at the opening.
We're just expecting pretty muted activity from a gain on sale perspective in the first half of the year and hoping it it opens up in the second half, but one other thing I did say that I wanted to reiterate.
<unk>.
Now that we've got our gain on sale.
As a percentage of quarterly revenue.
Somewhere in that 7% to 10% revenue range.
And gives us a total revenue mix of let's say around 80%.
Fred income, 20% fee income versus historically over the last couple of years, we've been more 70 30 I think.
That's actually a pretty good place for us to be it minimizes our.
Our gain on sale.
And frankly reliance on gain on sale every quarter allows us more flexibility to sell more if we see attractive pricing sell less if we want to hold more but then importantly, it gives us much more recurring revenue through NII and balance sheet growth, which we think is certainly more predictive.
<unk>, and obviously attractive to us and to investors. So.
This is actually given us an opportunity to kind of reset what our gain on sales strategy is and grow more balance sheet.
Thanks, Vijay I appreciate that and then just one last one for me.
Kind of Dovetailing off of your last point, but I'm just curious what your outlook is on the loan and origination growth.
In the past several quarters ago, you've talked about kind of longer term trends are 15% origination growth.
Do you think levels like that is still attainable right now or do you think growth like that needs to come down given the current environment.
Using balance sheet origination growth Chris.
Yeah.
Origination, but also looking for both as well.
Yes.
Yes, so on the origination side, we continue to add lenders last year and I think we have the franchise in place to do that.
So we did $4 billion of total origination last year to think that we could grow that 15% in sort of a normal environment seems quite reasonable I think we're obviously being pretty conservative right now looking at the implications of a slowing economy interest rates construction costs.
And largely M&A market things like that so.
We feel good right now kind of at where we are or up but.
But certainly the franchise is in place to do that sort of 15% and as we look at just the overall size of the market. The overall trends in the silver tsunami.
The transition of ownership as chip talked about it still feels like there's just a ton of opportunity for us to continue to expand the lending franchise, we're just going to do it really prudently.
As we kind of look and see what 2023 looks like.
Thanks sounds like alright, thanks for taking my questions.
Yes.
Thank you.
Okay and one moment please for our next question.
Thanks.
Our next question will come from Michael Perito of K B W. Your line is open.
Yeah.
Hey, guys. Good morning, Thanks for taking my questions.
I wanted to start kind of.
Two bigger picture questions.
One just on how are you guys thinking about it.
There's been some discussion on this call about expense growth moderating positive operating leverage.
NIM, having some more pressure, but then hopefully stabilizing you know kind of taking it all into sort here I mean, what what's the updated thoughts you guys have on.
Kind of structurally what the targeted Roe.
Should be for this business I mean, you guys are outgrowing the balance sheet a bit more maybe theres a little less gain on sale, maybe that weighs on our little near term, but just curious if theres any kind of profitability thoughts youre willing to provide as you guys kind of look out over the next couple of years with what you know today in terms of what you think is reasonable or should be targeted for the type of business you're building.
Yes, that's a great question, Mike we talk about that a lot here.
We've consistently grown our balance sheet.
North of 20% actually I think over a sustained period of time, we still think that 15 plus percent balance sheet growth.
It makes sense for us as a franchise as we look at sort of where we're going.
The simple math says the 15 plus percent ROE allows you to self fund that and continue to grow without having to sort of.
Tap into capital markets, which is which is nice it creates a lot of flexibility for us on that path.
We look at our franchise a 15% Roe.
I think it's quite reasonable, especially as we start to turn the dial on on the deposit side that we've been talking about and start layering in checking accounts, which is a pretty capital efficient place to to grow earnings by lowering our cost of funds. So.
Would love to think that we could turn that dial to be a 20% ROE and a 20% grower that sort of I think the.
Optimistic case, but pretty reasonably think that a 15% Roe.
To support our growth is pretty reasonable BJ. If you have anything on that no I think that's right and kind of are.
Arrow in the quiver so to speak is.
Sure.
The view.
If you normalize some of these one time costs and the gains in all of this.
We're up 15% to 20% ROE business today with a deposit platform that as market rates and as Huntley mentioned this is our year of checking.
And really getting focused on that and so over the next several years as we continue to grow our business and build out a small business bank.
We are.
Anticipating that.
Funding cost is going to be a tailwind to us as we continue to improve profitability.
Got it that's helpful, but it's fair to think that.
On a GAAP basis.
There'll be a process to build back up to that 50% right.
Over the next year or two as some of those initiatives take hold it at rates stabilize it et cetera is that fair.
Yes, I think that's fair Mike.
And then kind of Dovetailing off that you guys kind of brought this up but.
I think P. J you bet should that at this point youre not expecting any exits.
2023, the venture side.
From a timing perspective, it feels like 2023 will be a year, where the balance sheet growth outpaces the Roe at.
At least as it looks right now so I was just curious on the capital front.
Clearly with the bites now of holding more of your production could you also just maybe provide this internally what you guys are thinking about in terms of capitalization of the bank and what's kind of the target range. If you were to go up.
Above or below that what would be kind of your priorities to rightsize that.
Yes, I think if you look at where we sit today kind of the common equity tier one ratio of 12, 5% is.
It is quite solid.
Where we have.
Our binding constraint as we continue to grow is really more of the leverage that and we are unique in that 40% of our loan book is government guaranteed and so.
Leverage is a little bit less relevant to us, but obviously still a an important in headline ratio. So thats one that we continue to watch we're at 93 today.
From a holding company or bancshares perspective, which still remains very healthy.
Even if we grow the balance sheet faster than the retained earnings we still have a couple of years of runway.
Hi.
Before tier one leverage gets down at the bankshares level towards.
Seven five or 7% range in which case, we would probably have to think of something else absent more ventures gains. So right. We do have some runway as the balance sheet grows.
Very helpful. Thank you and then just lastly for me.
I know, it's hard but any thoughts on a range on the tax rate for next year P. J just given some of the credit activity you've done already.
Was there any guardrails, if you could give us on that.
Yes.
Sure.
Sorry.
Yes.
That's a tough one.
Honestly, a tough one for me too.
I would say our statutory rate blended is going to be around 23%.
I would use 20%.
An effective tax rate to model now it's going to.
Kind of go up and down quarter to quarter, but thats, probably the best range.
We are.
If we do see attractive tax credit investments that we want to make.
That could certainly.
Shifting and be more positive, but right now <unk> is probably the best place to land.
Okay, great. Thank you guys I appreciate it.
Thanks, Mike.
Thank you.
And Im seeing no further questions in the queue I would now like to turn the conference back to chip Mahan for closing remarks.
Well this will be brief see 90 days folks.
This concludes today's conference call. Thank you all for participating you may now disconnect and have a pleasant day.
The conference will begin shortly two reasons lower Johan during Q&A, you can dial star one one.
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Okay.
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Yes.
Okay.
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